It seems the debate on interest has actually stirred interest among readers on the topic. Approaches made through emails and calls have raised a few questions – some old and some new. I will wait for more comments and shall try to address them in one go or as and when possible without impacting our scheduled plan of topics for the series. So, today we are moving ahead with our new subject of differences between Islamic and conventional banks.
It may raise many eyebrows if I say that the only common aspect between the business models of the two types of banks is the word ‘bank’. To prove this, there must be a valid explanation since on the surface both types of banks look precisely the same.
Similarities between the two types of banks include a matching layout of branches, well-attired and courteous staff, both receive and pay cash and cheques, have ATMs and lockers, provide scores of the same online and offline banking services, entertain funding requests from individuals and businesses, maintain identical organizational setups, have a general assembly, board of directors, a CEO and senior management team to run the bank, most of them have their shares listed on stock exchanges and … the list goes on.
Without denying what has been stated, I will still insist on my opening statement of this article and shall explain why. To start with, a famous scholar, belonging to the lineage of a reputed scholarly family, described it in an interesting manner at an Islamic finance conference in Istanbul a few years ago where I was also present.
The scholar showed the pictures of two beef burgers on the screen and asked the audience as to which one is Halal? Since both burgers were undistinguishable, it was impossible for anyone to pinpoint the Halal burger. He then showed the next slide marking the burger on the left to have been prepared with Halal meat. I thought he tried to convey the message of ‘identical yet different’ well through this example but it is a bit more than that when it comes to a deep scrutiny of the two types of financial institutions.
After having understood the forbiddance of interest, the pitfalls of an interest-based economy and the disorder that it continues to create for mankind from time to time, we would now examine whether banking and finance could survive without interest!
We shall first examine how an Islamic bank treats the deposits received from customers in comparison to the conventional bank. In simple terms, a conventional bank borrows funds from its customers (depositors) for an agreed time frame and at a predetermined rate of interest, and lends the same to its customers, again at a pre-fixed interest rate and tenure. The interest amount paid by the bank to depositors is considerably lower than the interest amount it recovers from the borrowers. The difference becomes the profit for the conventional bank.
Moreover, while the conventional bank holds the discretion to raise the interest rate on the funds lent to the borrowers at a short or no notice, the depositors whose funds are used by the bank are deprived of such luxury. On maturity of the deposit tenure, they receive the interest amount based on the rate fixed by the bank even if the bank had continued to raise the interest rate on its lending during the deposit tenure. This is the first inequality in the conventional banking system that readers should take note of.
The first and foremost difference in Islamic banks is that they do not carry out the business of borrowing and lending the money on interest. They do accept funds from depositors – similar to what conventional banks do – but not as a borrower. They do this activity as the manager of customers’ funds.
The role of a borrower in accepting customer deposits creates instant liability to return the money with agreed interest for the conventional bank. However, accepting funds from customers under a fund management contract does not trigger such liability but prompts a fiduciary responsibility to invest the customer deposits in a profitable manner for and on behalf of the customer. This is important to note that since the Islamic bank acts as the fund manager for the customer, there can be no commitment for a pre-agreed rate of return to be paid to the customer on such funds.
The contract entered into between the Islamic bank and the customer is termed as Mudarabah (fund management contract), the customer is called Rab Al Maal, ie the owner of the funds whereas the Islamic bank is called the Mudarib or manager of the fund.
The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions of the Dubai Islamic Economy Development Centre, nor the official policy or position of the government of the UAE or any of its entities. The purpose of this article is not to hurt any religious sentiments either consciously or even unwittingly.
Sohail Zubairi is the projects advisor with the Dubai Islamic Economy Development Centre. He can be contacted at [email protected].
Next week: Discussion on the differences between Islamic and conventional banks shall continue.