The journey of Islamic banking started with the aim of conducting banking business in accordance with Islamic Shariah in Muslim countries all over the world. The journey of the Islamic Bank in Bangladesh began in the 1980s with the establishment of Islami Bank Bangladesh Limited. At present, a total of 10 full-fledged Islamic banks are operating in Bangladesh. According to Bangladesh Bank, at the end of June 2021, in terms of deposits, BDT 3,27,94,300,00,00,000 or 27.26 percent of the entire banking sector of Bangladesh was under the Islamic banking sector.
There are some major differences between the principles of conventional banking and Islamic banking that distinguish it from the conventional banking system. However, what exactly are the differences between Islamic banking and commercial banking?
Overview of Islamic Banking
Islamic Bank is a financial institution whose status, rules, and procedures are governed by Islamic Shariah and will refrain from accepting or paying any interest on any transaction. On the other hand, commercial banks’ primary source of revenue is by charging interest through lending money to the customers. Although there is disagreement among many about the activities of Islamic banks in Bangladesh, the main objective of Islamic banks is to conduct banking activities in such a way that they can help achieve all kinds of objectives of the Islamic economy.
Islamic banking has been around since the Medieval era. European banking principles were initially used for financial transactions between the Middle East and Europe. However, as trading continued to increase over time, European countries began to establish local branches of the bank in the Middle East. These region-based banks were initially operated on no-interest financial systems or profit and loss sharing methods. By adopting this method, European banks were able to serve Muslim businessmen.
According to Correctislamicfaith, based on the concept of profit and loss sharing and Mudaraba, some Islamic scholars like Anwar Qureshi, Naeem Siddique, Mahmud Ahmed, and Mohammad Hamidullah proposed interest-free banking through their various publications from the 1940s to the 1960s.
Over the next two decades, as the number of young Muslim economists grew worldwide, the idea of interest-free banking became more popular. During the 1970s, as a result of a conference of finance ministers and Islamic economists from several Muslim countries, the world’s first interest-free bank, the Islamic Development Bank, was established in 1975. In the same year, the world’s first private interest-free bank, Dubai Islamic Bank, was established by Muslim businessmen worldwide. Over the next ten years, more than 50 more interest-free banks were established globally. Although at the time, most of these banks were established in Muslim countries, several Islamic banks were based in the 1980s in Denmark, Luxembourg, Switzerland, and the UK in Western Europe.
Islamic banking in Bangladesh started with the establishment of Islami Bank Bangladesh Limited in 1983. Later on, in 1997, the second Islamic bank of the country, the Al Baraka Bank Ltd, was established. However, in 1996, two more banks, Al-Arafah Islami Bank Ltd and Social Investment bank Ltd. were given clearance to operate under the Islamic Banking Principal. Therefore they also started banking activities following Islamic Shariah. In May 2001, another bank, Shahjalal Islami Bank Limited, began its operations. Subsequently, two traditional banks, Export-Import Bank ltd. (EXIM Bank), and First Security Bank was converted into Islamic banks, and in 2004 Exim Bank started operations as an Islamic bank. According to Bangladesh Bank, there are currently ten full-fledged Islamic banks operating in Bangladesh, with a total of 1569 branches. In addition, eight more conventional commercial banks have 39 Islamic banking branches across the country.
Meanwhile, 13 conventional commercial banks in the country have 194 Islamic banking windows, providing Islamic financial services in Bangladesh. In addition, since May 2021, Mutual Trust Bank Limited has started offering Islamic Financial Services through its dedicated windows. Furthermore, in December 2021, The City Bank launched their redesigned Islamic banking service City Islamic.
According to Bangladesh Bank, by the end of June 2021, 27.26 percent or BDT 3 crores 26 lakh 94 thousand 300 Crore (BDT 3,27,94,300,00,00,000) of the entire banking sector in Bangladesh in terms of deposits and 27.55 percent in terms of investment is under the Islamic banking sector of the country. In addition, from April to June 2021, the total remittances in the Islamic banking sector amounted to BDT 20,03,900,00,00,000, which is 38.24 percent of Bangladesh’s total remittance. There are about 43,909 people employed in the Islamic banking sector in Bangladesh.
On the other hand, according to Thelawreviews, in 2021, a total of 505 Islamic banks were operating, including 207 Islamic banking windows. Furthermore, according to Statista, in 2020, Saudi Arabia held the highest number of Islamic Banking assets shares worldwide percent, which was 50.6 percent. In addition, the total volume of the global Islamic finance market that year was $2.88 trillion.
Islamic vs Regular Banking
There are several differences between conventional commercial banking and Islamic banking. However, the first and the main difference between these two types of banking is interest. In the case of commercial banking, banks impose a fixed rate of dividend on the principal amount to ensure their profit. But according to Islamic prohibitions, any kind of pre-determined & fixed dividend on any type of loan or investment is considered interest. Profit or loss is always uncertain in any investment. Therefore, accepting and giving fixed dividends in the Islamic investment system is prohibited in case of a loan or investment. In contrast, Islamic banks resort to PLS or Profit and Loss Share. This means, the loan given to customers is mainly an investment for Islamic banks, whose profit or loss will be shared by the bank with the customers.
In the case of regular banking, all types of functions and operations are operated based on manmade principles. On the other hand, all Islamic banking activities are conducted following Islamic Shariah. In addition, regular banks aim to maximize profits without any restrictions. Meanwhile, even though Islamic banks are working towards profit maximization, banks have an obligation to operate following all restrictions of the Islamic Shariah. Moreover, conventional commercial banks do not conduct any Zakat-related activity. At the same time, the collection and distribution of zakat in the modern Islamic banking system have become part of the regular services of Islamic banks.
The fundamental function of commercial banks is collecting interest on loans. On the other hand, the fundamental function of Islamic banks is to provide security to the money deposited by the customer. In return for that money, the customers share in the profit and loss of the bank’s business, or the bank shares the profit and loss of the customer’s business against the loan given to the customer. While regular banks charge defaulters an extra compound interest rate, defaulters are not charged extra according to Islamic banking rules. Although it is quite easy for interest-based commercial banks to collect funds from the money market, it is relatively difficult due to the various restrictions in Islamic banking.
Due to the fixed interest rate, the amount of income is also guaranteed in the regular banking system. As a result, banks do not attach much importance to expert development for project appraisal and evaluation. However, since profit and loss are shared with the client in the Islamic banking system, the banks also place special attention on project appraisal and evaluation.
Regular banks generally place more importance on the customer’s creditworthiness; on the other hand, Islamic banks focus more on the project’s viability. In the case of the commercial banking system, the relationship between the bank and the customer is as a creditor and a debtor. Still, in Islamic banking, the client and the bank maintain a partner, investor, and trader relationship.