The key features differentiating between Islamic finance and conventional finance are summarized in the following table:
| Islamic Finance | Conventional Finance |
| The principles and rules of shari’ah are the basis for all modes of finance and investment. | It is governed and regulated by man-laid principles. |
| Money is a medium of exchange and store of value, but not a commodity. Money always trades at face value. | Money is a commodity (also of course a medium of exchange and store of value). It can be traded at a price higher or lower than its value . It can also be rented out. |
| Reward is only a consequence of taking risk. Islamic finance is mainly about risk taking and risk sharing. | It mainly focuses on elimination of risk and transfer of risk. |
| No pre-determined rate of return is guaranteed. It promotes risk sharing the providers of capital (investors) and the users of funds (entrepreneurs). | The providers of capital are assured of a pre-determined rate of return. Collateral and guarantees are posted so that the credit risk is nil or negligible. |
| The basis for earning profit is trade of goods or services. Time value of economic resources is the key driver in transactions. | Time value of money is the basis for charging interest on capital. |
| Profit and loss sharing governs the relationship between the providers of capital and the users of funds. In musharakah based modes, the partners share profit and losses, while under mudarabah, it is the capital provider who takes the hit, while the entrepreneur loses only his share in profits unless in case of negligence, etc. In trade and lease based modes, the return may be fixed but still it is linked to utilization of economic resources. | Interest is charged or paid irrespective of the outcome of borrowing. The return is fixed. It is linked to demand and supply of loanable funds. |
| Funding is linked to the real economy, i.e., the execution of agreements for the exchange of goods and services (e.g., in contracts of murabahah, salam, istisna’a, etc.) | For cash financing, revolving financing, and working capital financing, the exchange of goods and/ or services is not required. Transactions are purely financial. |
| The link with the real sectors of the economy leads to balanced expansion and contributes directly to economic and social development | Focus on financial economy and financial transactions and the use of money as commodity lead to inflation, imbalances, and financial crises |
| Excessive gharar (gharar fahish) is impermissible. Transactions are win-win. Mutual benefit is maintained by covering and spreading risks of contractual agreements: obligations are set clearly at contract date. | Transactions and activities involve a great deal of gharar (e.g., conventional insurance, derivative contracts, etc.) |
| Shari’ah prohibits collection from defaulters. However, penalty (for late payment) is charged, and is channeled to charity (rather than considered a source of income for lenders/ creditors) | Interest is charged irrespective of force majeure (such as the case of default). Default also justifies that lenders/ creditors charge penalties and accordingly adjust creditworthiness of borrowers/ debtors (which means more risk premiums can be added for future dealings, etc) |
| It discourages the production of goods and services that are deemed haram (impermissible) and as such are armful to the society and individuals (e.g.., gambling, alcohol, etc.) | It does nothing to avoid financing the production of goods and services that pose a threat to the society and individuals. |
| IFI– client relationships are that of partners, investors and traders, buyers and sellers, lessors and lessees, etc. | The relationship between financial institutions and clients are that of creditors and debtors. |
Comments