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Difference Between Islamic Banking and Commercial Banking & Features of Islamic Economic System in Pakistan
“Banking Operation & Islamic Banking”
On the topic
“Difference Between Islamic Banking and Commercial Banking
& Features of Islamic Economic System in Pakistan”
“Sir Nouman Dar”
Muhammad Shaban MCE 12169
Yasir Ali MCE 12154
Mutahir Bilal MCE 12147
Nadia Izhar MCE 12170
Conventional Banking ………………………………….. 3
Islamic Banking ………………………………….. 3
Difference bw Conventional and Islamic Banking……… 4
Challenges of Islamic Banking………………………………….. 7
Islamic concepts of a economy b/w Economics and Law… 10
Islamic Banks into Conventional Banking Systems…….. 11
Shariah Compliance …………………………….…… 11
Legal and Regulatory Adaptations………………………….. 11
Segregation of Funds……………………………….…. 12
Accounting and Auditing Standards ……………….…..... 12
A commercial bank (or business bank) is a type of retail bank that provides services,
such as accepting deposits, giving business loans and basic investment products.
A financial institution that provides services, such as accepting deposits, giving
business loans and auto loans, mortgage lending, and basic investment products like savings
accounts and certificates of deposit. The traditional commercial bank is a brick and mortar
institution with tellers, safe deposit boxes, vaults and ATMs. However, some commercial
banks do not have any physical branches and require consumers to complete all
transactions by phone or Internet. In exchange, they generally pay higher interest rates on
investments and deposits, and charge lower fees.
Categories of commercial banks in Pakistan:
Commercial banks operating in Pakistan can be divided into four categories:
Nationalized Commercial Banks (NCBs),
Private Banks and
A banking system that is based on the principles of Islamic law (also known Shariah)
and guided by Islamic economics. Two basic principles behind Islamic banking are the
sharing of profit and loss and, significantly, the prohibition of the collection and payment of
interest. Collecting interest is not permitted under Islamic law.
Fundamental of Islamic Banking:
Shariah laws are the tenets of Islamic Banking. As such, the comparison with
that of the conventional are not exactly like-to-like.
Conventional banking was build upon the fundamentals of debtor-creditor
relationship with interest being the price of credit and reflecting the
opportunity cost of money. Hence, money is a commodity somewhat.
Financial relationship in Islam is generally participatory in nature. E.g. the
principles of Musharakah and Mudharabah, or contractual transaction. In
addition, risk and reward relationship is guided by the socio-economic
Islamic Bank in Pakistan:
Bank Islami Pakistan Limited
Dubai Islamic Bank Pakistan Limited
Meezan Bank Limited
Al Baraka Bank (Pakistan) Limited
Emirates Global Islamic Bank
Basic Differences between Islamic and Conventional Banking:
Islamic Banking Conventional Banking
The functions and operating
modes of Islamic banks are
based on the principles of Islamic
The functions and operating
modes of conventional banks
are based on fully manmade
principles (largely capitalism
It promotes risk sharing between
provider of capital (investor) and
the user of funds (entrepreneur).
The investor/lender is
guaranteed of a predetermined
rate of interest or returns.
It also aims at maximizing profit
but subject to Shariah
Unrestricted profit maximisation
illustrated by derivatives trading.
In the modern Islamic banking
system, it has become one of the
service-oriented functions of the
Islamic banks to be a Zakat
Collection Centre and they also
pay out their Zakat.
It does not deal with Zakat.
Participation in partnership
business is the fundamental
function of the Islamic banks. Understanding
the venture is
therefore essential. Embedded
Lending money and getting it
back with compounding interest
is the fundamental function of
STRICTLY PRIVATE & CONFIDENTIAL
Understanding the venture is
therefore essential. Embedded
the conventional banks. Money
is a commodity and the
It can charge additional money
(penalty and compounded
interest) in case of defaulters.
Islamic banks have no provision
to charge any extra money from
the defaulters except for
compensation (typically such
proceeds is given to charity).
Rebates early settlement at the
Due importance to the public
interest/ maslahah. Its ultimate
aim is to ensure growth with
Often, lenders/banks interest
becoming forefront. It makes no
effort to ensure growth with
For the Islamic banks, it must be
based on a Shariah approved
For interest-based commercial
banks, borrowing from the
money market is relatively
STRICTLY PRIVATE & CONFIDENTIAL
Since it shares profit and loss,
the Islamic banks pay greater
attention to developing project
appraisal and evaluations.
Since income from the
advances/loans is fixed, it gives
little importance to developing
expertise in project appraisal
and evaluations. Risks are
transferable at a price (and
The conventional banks give
greater emphasis on creditworthiness
of the clients where
credit equals to ‘commodity
Greater emphasis on the viability
of the projects.
The status of Islamic bank in
relation to its clients is that of
partners, investors and trader,
buyer and seller.
Relationship is often defined as
that of creditor-debtor.
Islamic bank can only guarantee
deposits for deposit account,
which is based on the principle of
al-wadiah, thus the depositors
are guaranteed repayment of
their funds, however if the
account is based on the
A conventional bank has to
guarantee all its deposits.
mudharabah concept, client have
to share in a loss position.
Its functions and operations follow the
Qur’an and the Sunnah as much as possible.
Its functions and operations
are based fully on man-made
In its investment product,an Islamic bank
promotes the sharing of risk and
profit between investor and investment fund
manager.There is no fixed profit
promised. Division of profit is based on real
In its investment product, the
investor is promised a fixed
rate. In reality, it is a riba based
Aiming for profit that adheres to Islamic
discipline that is limited to that which
Aiming for profit without
religious or moral boundaries.
Its retail product utilizes thetrading or
renting of an asset,and not the loan
The retail loan product applies the system of
giving out loans with multiplied interest.
Charges compensation for any late payment,
but it does not go toward the bank’s
earnings.Instead, it is channeled directly to
Charging a compounding penalty on a loan if
there is late payment.
Participation in partnership business is the
fundamental function of the Islamic banks.
So we have to understand our customer's
business very well.
Lending money and getting it back with
compounding interest is the fundamental
function of the conventional banks.
The Islamic banks have no provision to
charge any extra money from the defaulters.
Only small amount of compensation and
these proceeds is given to charity. Rebates
are give for early settlement at the Bank's
It can charge additional money (penalty and
compounded interest) in case of defaulters.
It gives due importance to the public
interest. Its ultimate aim is to ensure growth
Very often it results in the bank's own
interest becoming prominent. It makes no
effort to ensure growth with equity.
For the Islamic banks, it must be based on a
Shariah approved underlying transaction.
For interest-based commercial banks,
borrowing from the money market is
Challenges of Islamic Banking:
Shariah interpretation versus the
financing commercial viability.
Legal jurisdictions and governing laws.
Transparency, accountability and
governance for public and
Tax incentives, pervasive government
intervention and controls.
Supervisory and prudential regulatory
Lack in depth capital markets and
Accounting and auditing standards.
Since it shares profit and loss, the Islamic
banks pay greater attention to developing
project appraisal and evaluations.
Since income from the advances is fixed, it
gives little importance to developing
expertise in project appraisal and
Evaluation also stresses on the potential or
viability, performance and prospect of the
project that is being financed.
Evaluation stresses on the ability of the
borrower to pay off the loan. Not
much attention is given to the progress of
the customer’s project.
Profit according to the concept of sharing
profit-loss; the bank gives more attention on
investing in project development.
Earn revenue from fixed interest charged to
The bank-customer relationship: seller,
buyer or partner.
The bank-customer relationship: loan lender
Islamic Economic System in Pakistan:
Capitalism, Communism and Mixed Economics system has purely a materialistic
approach in which human social life has no importance. But in Islamic System, the followers
of Islam are required to lead a material life in such way that it becomes a source of
happiness and respect of others in this world for making secure himself for next world.
Islamic Economic System consist of institutions, organizations and the social values
by which natural, human and manmade resources are used to produce, exchange, distribute
and consume wealth? Goods and services under the guiding principles of Islam to achieve
"FALAH" in this world and also other it.
Salient Features of Islamic System:
Main characteristics of Economic System of Islam are:
The Concept of Private Property
Consumption of wealth
Production of wealth
Distribution of wealth
The concept of Zakat
Interest free Economy
Responsibilities of the Government.
1. The Concept of Private Property:
Basic Principles in Islam for Consumption or Investment of private property are:
Concept of "HALAL" and "HARAM" for earning or in production and
consumption of wealth.
A property cannot be used against public interest.
Show much as you have something.
Real/money Capital cannot be used for gain.
Payment of Zakat is compulsory.
2. Consumption of Wealth:
In Islamic System uses of luxuries are not allowed because it against the concept of
"TAQWA" should have distinguish between "HALAL" and "HARAM"."BUKHAL" and "ISRAF"
are to be avoided.
3. Production of Wealth:
Price mechanism plays a key role in carrying out the production process in an Islamic
Society. As Price system results in the expectations of workers and consumers the Govt.
Interferences with the price mechanism to over come the problem. These things are not
allowed in Islamic System.
Production of drugs, gambling, lotery, music, dance etc.
Lending and borrowing on interest
Black marketing, Smuggling etc.
4. Distribution of Wealth:
Islamic Economics System favour fair (not equal) distribution of wealth in the sence
that it should not be confined to any particular section of the society. For fair distribution of
wealth Islam gives following steps:
"BUKHAL" and "ISRAF" are to be avoided.
Payment of Zakat
Interest not allowed
Monopoly of Private firm not allowed
Earning from Black Market.
5. The Concept of Zakat:
Zakat is a major source of revenue the government in an Islamic state. It levy on all
goods and money or on wealth if have to pay yearly on the month of RAJAB or RAMADAN.
6. Interest free Economy:
The whole financial system the bank structure in particular is run on the basis
"SHARAKAT" and "MUZARABAT" in Islamic state. Therefore, Islamic economics is an interest
7. Responsibility of the Government:
Responsibility of the Islamic Government are
Should check un-Islamic activity like gambling, smuggling, black marketing
Should secure poor people by giving them necessity of life i.e. food, clothing,
Should provide equal employment opportunity.
Social and Economic Security is required to guaranteed by the Govt.
Islamic concepts of a economy between economics and law:
The prevalent doctrine of Islamic economics today can be summarized as follows:
Islam conveys a positive outlook on this life in general and provides a
supportive value system for economic activities in particular.
Islamic economic ethics exhibits considerable overlap with Western-Christian
perceptions in the field of individual ethics. Great importance is ascribed to
Individuals are expected to earn their living through their own work. A
person’s own achievement (physical and intellectual work) is the most
important basis for legitimately obtaining material goods and wealth.
Islamic Banks into Conventional Banking Systems:
Financial products and institutions will impose on the regulated entities, as well as
the potential implications of the interaction between Islamic and conventional banks. This
section reviews four areas of paramount importance that practitioners and supervisors need
to appreciate in order for Islamic banking to be successfully introduced into a conventional
Compliance with the Shariah
Segregation of Islamic and conventional funds
Legal and regulatory adaptations
Transparency and awareness campaigns.
Sources of Financing in Islamic banking
There are the following sources of financing.
Islamic finance in based on the principles established by the Shariah as well as other
jurisprudence or rulings, known as fatwa, issued by qualified Muslim scholars. Admittedly,
some of the issues covered by these rulings can be quite complex, forcing the institutions
involved to often seek the assistance of experts in interpreting them. As a result, it has
become a common practice for Islamic banks to appoint their own board of Shariah
scholars. Nevertheless, since expertise in these matters is still relatively scarce in some
countries, different Islamic banks often share the same scholars. This phenomenon has the
beneficial side-effect that it promotes consistency across the services and products offered
by these institutions. The fund aimed at drawing funds from the Gulf region. Initially, the
fund experienced difficulties in attracting investors, as it lacked a Shariah board, and thus it
was viewed with reticence by Gulf investors. After some time, a Shariah board was
appointed and the fund took off successfully.
Sources of sharia law:
Interpretations of the Qur'an
Interpretations of the Sunnah
Ijma, consensus amongst scholars ("collective reasoning")
Qiyas/Ijtihah analogical deduction ("individual reasoning")
Legal and Regulatory Adaptations:
One of the questions that will need to be resolved promptly as Islamic banking
emerges within a conventional system is how to embed Islamic activities into the existing
juridical framework. To think about this issue, it is useful to adopt a two-tier perspective and
address first the legal aspects of Islamic contracts, and second, the regulatory aspects of
Islamic financial transactions.
Segregation of Funds:
An important principle behind Islamic finance is the desire to maintain the moral
purity of all transactions. The funds intended for Shariah-compatible investments should
therefore not be mixed with those of non-Islamic investments. This requirement is not
based on the assumption that the activities of non-Muslims are intrinsically impure. The
rationale behind this principle is rather one of prudence, in the sense of taking all the
necessary precautions to ensure that Islamic funds do not become mixed with other funds
that may be involved with riba, gharar, or haram activities.
Therefore, in order to ensure compliance with Islamic principles, conventional banks
wishing to offer Islamic products must guarantee and publicize that the funds devoted to
conventional activities will not be mixed (commingled) with those destined for Islamic
activities. In operational terms, this requires that banks establish different capital funds,
accounts, and reporting systems for each type of activity. In this sense then, when a
conventional bank opens an Islamic window, to a large degree, it is in fact establishing a
separate entity from the rest of the bank.
Accounting and Auditing Standards:
The rapid expansion of the Islamic financial industry that started in the 1970s was
not initially accompanied by the creation of a set of internationally recognized accounting
rules. In consequence, Islamic institutions around the globe had to resort to developing their
own accounting solutions for their new products, rendering comparisons across institutions
difficult, and sometimes even giving the impression of lack of transparency. The need for a
body of accounting standards purposely designed to reflect the specificities of Islamic
products became even more pressing as new and more complex instruments were being
marketed. To close this widening gap, the Accounting and Auditing Organization for Islamic
Financial Institutions (AAOIFI) was created in 1990. One of the main goals of this
organization is to design and disseminate accounting and auditing standards that can be
applied internationally by all Islamic institutions.