1- In a conventional bank, a customer is given finances by a contract of loan where
the bank is creditor and the customer is debtor. On the other hand in Islamic
banking, finances are given to a customer by a contract of sale i-e a deferred sale
contract. In this contract, either bank itself buys goods or appoints the customer to
buy on its behalf and later sells them to the clients with a mark up (cost plus an
agreed profit margin). Payment is done in installments over a specific period of
time.
2- Islamic banks earn their profit by trading and investment activities and this profit
can be said legitimate as it involves risk and efforts as compared to conventional
banks which earn their profit by financing the customers at a fixed interest rate.
3- . Participation in partnership business is the fundamental function of the Islamic
banks. So they have to understand their customer's business very well. Whereas
lending money and getting it back with compounding interest is the fundamental
function of the conventional banks.
4- The Islamic banks have no provision to charge any extra money from the
defaulters. Only small amount of compensation and these proceeds are given to
charity. On the contrary, conventional banks can charge additional money
(penalty and compounded interest) in case of defaulters.
(Al-Omer & Abdul-Haq 1996)
5- The nature of Islamic banking is not simply lending the money as experienced by
a conventional bank, but it is involved in selling and buying the commodity. Thus
the selling price which is a cost price plus the profit margin, which is the
contracted amount. In conventional banking practice, interest is regarded as the
price of loan. For example, if the worth of asset is $ 50,000 and interest rate is
15% per year, the price of the loan to be paid by the customer will be $57,500.
6- Profit amount agreed once between the customer and an Islamic bank remains the
same, e.g., in murabahah or cost plus profit is fixed at the time of contract and
must be agreed upon by the customer. If customer is unable to pay on time, bank
cannot ask for a higher price due to delay in settlement of dues. While interest rate
is also prefixed at the time of contract would be either unchangeable or would
change according to the Base Lending Rate (BLR) which is monitored by the
central Bank.
7- Islamic banks face more risk as compared to conventional banks. Although both
have to take credit risks, capital adequacy, liabilities and asset-matching risks,
currency fluctuation and liquidity risks, the risk for Islamic banks is higher.
Because Islamic banks have to face profit and loss in each deal in order to earn
profit but in conventional banks, the risk of loss is borne entirely by the client and
the lender (bank) safeguards itself against any possibility of loss. However
interest rate risk is faced by only conventional banks and not by Islamic banks as
interest is not permitted in their operations.
8- Islamic banks cannot remain unconcerned about the nature of the activity for
which they are financing. They cannot finance any business which is against the
teachings of Islam. While conventional banks don’t have to follow any limitations
of religion and they may finance any profitable activity e.g., a gambling casino or
an alcoholic manufacturing industry etc.