Islamic Banking Vs Conventional Banking

The commitment of Islamic banks in their dealings with the provisions of Islamic Sharia, distinguish them from the traditional banks.

The most important thing that distinguishes Islamic banks from conventional banks is their rely in their dealings on the principle of ”  share of profit and loss ” approved by Islamic sharia, while avoiding dealing with RIBA (bank interest), unlike the traditional banks that rely on riba based activities.

The traditional banks in their dealings with customers use one formula, which is interest-bearing loan under different names and formulas, while Islamic banks offer multiple legitimate formulas based on real sale and purchase, i.e. exchanging money with an existing commodity.

The difference between Islamic and traditional banks is also apparent in the fact that Islamic banks deal within the limits of their existing funds and do not employ them in prohibited activities, while the traditional bank often does not abide by Islamic Sharia law, as well as to deal with more than the existing funds using RIBA-based interest, which results in economic problems such as inflation.

Investment occupies a large part of the transactions of Islamic banks through the investment of funds through the adoption of various means and formulas, leading to the cooperation of capital and work, with the Islamic bank bearing the risks of investment. This is not true in traditional banks, that give great importance to lending operations at the expense of investment work.

Islamic banks, in addition to usual financial supervision, are subject to shari’a compliance control over their total work to ensure that they conform to the provisions of Islamic Sharia, through the Shariah Supervisory board, which is composed of a group of jurists of recognized competence and expertise. This Shariah control is the most prominent difference between Islamic and traditional banks.

Moreover, Islamic banks, in addition to their economic role, play a distinctive social role in the context of achieving social solidarity through their contribution to finding solutions to the problems that the society suffers from, such as the problem of housing through the provision of benevolnt loans, donations and zakat, while the traditional bank does not often care about these Aspects.

In continuation of this distinctive social role, the Islamic banks take in their dealings with the principle of mercy and tolerance and the ease that the Islamic sharia has called for, the debtor who can’t pay is treated with ease until he can make his pauments again, and the procrastinator debtor is called to pay penalty that will go to charity to avoid falling in riba. While traditional banks do not take into consideration those circumstances, if the debtor does not pay on time, he is fined or even worse to seize his encumbered funds and sell them at auctions at cheaper prices.

At the cultural level, Islamic banks are particularly important in supporting, enriching and disseminating Islamic economic thought through participation and the preparation of scientific meetings and conferences, as well as the publication of researches, studies and books dealing with economics and Islamic Banking to develop Islamic banking awareness.

In terms of profit determining and distribution, conventional banks rely on riba based financial activities, while Islamic banks make profit through real investment activities, and if a loss is incurred by the Islamic Bank. The revenue distributed to the investment accounts differs from one Islamic bank to another depending on the circumstances and the results of the investment operations in which the bank entered as a participant.

The difference between the Islamic bank and the traditional bank, and the advantages offered by Islamic banking, has been a magnet for a large segment of customers who are not in favor of dealing with traditional RIBA-based banks, as a result some of the traditional banks took the decision to convert to Islamic banks either in part by opening Islamic branches , or fully convert to Islamic banking.

It is necessary to apply what the sharia requires to convert from conventional bank to an Islamic bank, adhering to the provisions and principles of Islamic Sharia in all new operations after the transformation. Illegal operations concluded prior to the decision to convert are immediately disposed off, and may be delayed only as necessary or needed to take into account the actual circumstances of the bank, in order to avoid the risk of collapse, but to be disposed off in accordance with this standard.

The transformation of traditional branches into Islamic banking requires a transformative plan by taking some of the following practical actions:

• Identify the branches to be converted.
• Establishment of a team of specialists in the following departments: (Systems, finances, Shariah control, Islamic banking branches, training).
• Set the start date for executuion.
• Contacting customers by sending letters or arranging a meeting with customers.
• Take the necessary measures by preparing tools and finding alternatives for the prohibited activities, and qualifying the necessary human resources for proper implementation.
• Modify the license if the supervisory authorities require it, and amend the contract of incorporation and the statutes through the channels required to modify it by including objectives and means appropriate to the Islamic banking work.
• Rebuilding the organizational structure of the Bank, amending the Regulations and rules of work, job requirements and conditions of employment to suit the new situation.
• The formation of a shari’a board as well as an internal Shariah supervisory board according to the standards issued by the Accounting and Auditing Authority for Islamic financial institutions.
• Modifying or developing forms of contracts and documents consistent with the provisions and principles of Islamic Sharia.
• Take the necessary steps to implement the standards of accounting, auditing, controls and ethics issued by the Accounting and Auditing authority of Islamic financial institutions.
• Develop a plan to develop human resources to be able to deal with clients. This plan includes selecting individuals with experience in Islamic banking, preparing them and training them in Islamic banking.

It is also necessary to amend the method of dealing with the central bank, whether in the field of deposit or access to liquidity, etc., in a way that does not contradict the provisions of Islamic Sharia, especially with regard to RIBA-based transactions.

The relationship with traditional banks should be based on non-usury, the use of legally accepted formulas and the expansion of dealings with Islamic financial institutions through cooperation and coordination with them.

Banks wishing to convert to Islamic banks must, as part of this process, liquidate the resulting of past traditional operations in which they have obtained cash resources, whether with individuals, banks or the central bank. This liquidation includes deposits in accounts, premium investment shares, interest-bearing investment certificates, and loan bonds and so on, which were issued prior to the decision to conversion.

The only means of obtaining the necessary liquidity is to opt for shari’a compliant activities such as:

– The owners of equity increase their contributions by raising capital, attracting investment accounts and current accounts.
– Issuance of Islamic bonds (SUKUK), such as mudarabah Bonds, participation or leasing bonds…
– The sale of some of the bank’s assets and the leasing of them.
– Conducting salam sales operations in which the bank is a vendor, or Istisna’a transactions in which the bank is a manufacturer with the requirement to expedite the price of the Istisna’a (although it may be postponed).
– Conduct shari’a compliant tawarruq operations, by purchasing goods at a deferred price and then selling them at instant price to a buyer other than the first seller.

The bank, which has taken the decision to make the transition, must also stop ways of employing funds that are lending interest-based, and replace them with legitimate investment and financing formulas such as Mudarabah, Musharakah, Murabaha, Salam sale and Istisna’a… and other forms of legitimate investment.

It is also necessary to seek to terminate the RIBA-based loans that the bank has lent to others before the decision to convert to islamic banking, whether they short-term or long-term.

The bank must dispose of the incomes gained before the conversion, all of which is done without delay unless this is not possible if the immediate total phase-out leads to the paralysis of the bank’s activities or bankruptcy. In this case the bank can dispose of them gradually. The Intersets and other illicit gain must be spent in the good and public interest, as the bank may not benefit from it in any way, directly or indirectly, materially or morally.

As for the zakat due to the bank for the period before the decision to convert, if the conversion was done through the new owners of the traditional bank, who took the decision to convert it to an islamic bank, then, they should not give zakaah on the previous period.

The responsibility for the production of Zakat is set out in the Zakat Standard No. 9 issued by the Accounting and Auditing Authority for Islamic financial institutions. If the transformation is by internal decision of the bank, the Zakat is owed to the shareholders.

Finally, despite the difference between Islamic banks and traditional banks, they also have common denominators, given that these banks – Islamic and conventional– offer a range of banking services such as cheque issuance, and bank transfers… These services are not contrary to the provisions of Islamic sharia.