This report is about the comparison of Islamic and Conventional Banking, it provides the detail comparison of Islamic banking products and conventional banking products. Conventional Banking is based on collateral and interest on the other hand Islamic Banking is based on equal distribution of money without the involvement of interest. In Islam Bank is taken as a non-for-profit organization, which works for the betterment of the society by providing interest free loans and other interest free transactions, also providing products which will not lead the customers to any sort of future debts. Islamic banks also have an ethical investment charter which is not present in conventional banking (Hassan & Lewis, 2007). Islamic Banking also prohibits all products involving speculation and promotes the introduction of zakat. The principles of Islamic banking are as follows:
Prohibition of Riba (interest)
Profit Sharing (Mudharabah)
Safekeeping (Wadiah)
Joint Venture (Musharakha)
Cost Plus (Murabhab)
Leasing (Ijarah)
Conventional banking ignores most of these principles and is based on maximizing share holder's profit involving investments in futures, options and other financial derivatives opening doors to potential risk for its depositors. Conventional banking relies on financing profitable projects with interest lending (Hassan & Lewis, 2007).
Conventional banking and Islamic banking could be offered by the same bank and conventional banks must not foresee Islamic banking as a threat, rather both Islamic Banks and financial institutions can co-exist and act within secular commercial and contract law, and also it is possible to use national laws to serve their legitimate interests (Iqbal & Llewellyn, Islamic Banking and Finance: New perspective on profit-sharing and risk, 2002).
Therefore we have selected a banking offering both Islamic and conventional Banking products, now we will analyze the conventional and Islamic banking products of Abu Dhabi Islamic Bank (ADIB). Another study revealed that Islamic banking system is in no way inferior to conventional banking system, because Islamic banking system is just like any other banking system and is not just a religious movement. Further Islamic banking also provides a practical way for mediation and previous performance of Islamic banks in GCC shows that it is an attractive way of banking (Alkassim, 2005).
Selected UAE Bank:
The bank selected for the study is Abu Dhabi Islamic Bank (ADIB), ADIB was established on 20th May, 1997 as a Public Joint Stock Company, later on it started commercial operations in 1998.
adib_new-logo.gif
The mission of the company is to provide Islamic Financial Solutions for the global community (Mission & Objectives, n.d.).
Functions and Operations Modes of Islamic Banking Vs. Conventional Banking Products
ADIB offers Islamic banking products in personal banking section, consequently personal banking sector is chosen for further analysis. Following comparison by product feature details conventional and Islamic banking products offered by the bank under Personal Banking:
Comparison by Product feature & Financial Relationship
Islamic and Conventional Banking products will be analyzed with respect to their features.
Personal Banking
Conventional Banking
Accounts
Banoon Children's Saving Account
This product is targeted on children which is a conventional banking product, offering higher distributed profit rates for higher account balances. The product is targeted on customers looking to save up for children hence requiring good rate of return.In this product the customer develops a debtor creditor relationship with the bank.
Car Finance
This is a conventional banking product based on interest, the product features offer highly competitive profit rates. The Car Finance could also be approved on priority basis, it also comes along a ADIB Visa Cashback Card. The customer who opt for Car Finance donot have to transfer their salary account to the bank, which is also an added feature.
The product is targeted to maximize profit by forwarding loans on favourable rates and builds a relationship of creditor and a debtor with the customer.
Boat Finance
Is a conventional banking product with features of competitive profit rate and attractive available investment amount. The customers can obtain finance with out any mortgage also customers can postpone their finance when required.
This product is target to maximize profits of the bank based on lending finance on interest. The customers ends up building a debtor creditor relationship with the bank.
Islamic Banking
Ghina Savings Account
This product is based on Mudaraba, which is an Islamic banking product and refers to equal profit and lost sharing under Sharia Laws as listed in Banking Service Agreement. The customer develops a partner investor relationship in this product.
Current Account
This is also an Islamic Banking product based on the Islamic Principle of Qard Hasan. Under Qard Hasan the deposits are considered as a non-profit bearing loan to ADIB and the bank is bound to return the amount any time when requested by the customer. In this account the customer builds a relationship of Wadiah, which refers to safe keeping.
Motor Takaful
Motor Takaful plan is also an Islamic banking product based on Shari'a Law which also builds a relationship of investor and partner.
Penalties
The penalties subject to the products discussed above are explained in the new regulations of The UAE Central Bank, Regulations No.29/2011, which are effective from 1 May 2011. These regulations are intended to control lending activities and encourages banks to carry out proper checks on borrowers. The regulations also limit customers from borrowing more than 20 times their salary amount.
Risk Taking
Above conventional banking products include following risks:
Competitive Risk
The interest rates are determined following LIBOR, the fluctuations in LIBOR carry risks to all the customers of the conventional banking products.
Inflation Risk
All conventional banking products include inflation risk if the securitised asset increases in value this will impact the value of the repayment amount hence carrying inflation risks.
The Islamic Banking products involve following Risks:
Interest Rate Risk
All Islamic banking products involve Interest rate risk because Islamic banking is not a closed economy and if the interest rates hike the depositors will take out their deposits.
Liquidity Risks:
One of the major problems faced by Islamic banking is the absence of a Islamic Money Market which poses Liquidity risks to all the Islamic banking products as listed above.
Political Risks
Islamic Banking system evolving through times and still in the process of development poses political risks, if there is a change in the government. The new government may develop a different view for Islamic Banking, hence posing Political Risks.
Concentration of Assets Risks
Islamic funds could not be invested in tobacco or alcohol stocks hence congesting investment in few industries poses a concentration of Assets Risks in all the Islamic Banking Products.
Religious Risks
A halal product today may be deemed haram tomorrow which is also a risk in all the Islamic banking products.
Equity Market Risks
Islamic banking is based on profit and loss sharing as explained in Islamic Banking Products above, therefore equity market risk is built in all the Islamic baking products.
Conclusion
A study on Islamic and conventional banking revealed that once the bank and country controls are included, Islamic banks are more efficient than conventional banks and have higher capitalization ratios (Beck, Kunt, & Merrouche, 2010). Islamic banking is a new world of attracting opportunities but poses new risks to banking which must be addressed to develop into a successful Islamic Banking system.
Another finding of the report was that in general most of the Islamic banks are well capitalized, profitable and stable and most of the Islamic Banks also appear to be utilizing their resources efficiently, but still there's a lot to be done to be cost effective in their operations (Iqbal, Islamic and Conventional Banking in the nineties: A comparative Study, 2001). To be cost effective and counter Equity Markets risks new developments must be made to safe guard depositors from all the risks posed by Islamic Banking.
Appendix
Interview Minutes:
The interview with the manager at ADIB was conducted minutes recorded as follows:
5:00pm Meeting commenced with the manager Islamic banking and conventional banking ADIB.
5:05pm Explanation on offered Islamic and conventional banking products
5:10pm Relationship built with the customers in each product
5:15pm Risks involving each product
5:20pm Penalties
5:30pm Islamic Banking and Conventional Banking at ADIB
