Islamic vs Conventional Finance

Study Notes

Islamic finance aims to achieve Maqasid Shariah, protecting people's rights, and reaching success in both this world and the afterlife.
Conventional finance primarily focuses on profit maximization, allowing any actions as long as they generate profits and comply with the country’s laws.
Islamic finance promotes profit and loss sharing between the financial provider (bank) and customer (using Mudharabah and Musyarakah).
Conventional finance does not practice profit and loss sharing and focuses on deposit collection, interest payments, loans with interest, and interest-based investment.

Islamic finance relies on revealed sources: Al-Quran, Hadith, Sunnah, Ijma, Qiyas, and Ijtihad.
Conventional finance does not rely on revealed sources and is governed by human-made laws to safeguard financial institutions' interests.
Examples of Islamic finance regulation include the Islamic Financial Services Act 2013 (IFSA 2013), the Development Financial Institutions Act 2002 (Act 168), and the Shariah Governance Policy Document (SGPD).
Examples of conventional finance regulation: Financial Services Act 2013, Insurance Act 1996, Hire-Purchase Act 1967, and others.

Islamic finance is governed by principles like prohibiting uncertainty (Gharar) and speculation (Maysir).
Conventional finance allows for uncertainty in contracts and may involve speculation or gambling activities.

Deposits:
- Islamic finance uses Wadiah (safekeeping), Qard (principle-based loan), Tawarruq (commodity sale) for deposits.
- Conventional finance uses interest-based deposits.
Fixed Deposits:
- Islamic finance uses Mudharabah and Tawarruq.
- Conventional finance uses interest-based investments.
Financing:
- Islamic finance uses Tawarruq, Musharakah Mutanaqisah, Al-Ijarah Thumma Al-bay (rental and sale contract) for personal, home, and vehicle financings.
- Conventional finance uses interest-based loans and hire-purchase (vehicle financing).
Investment:
- Islamic finance uses Mudharabah, Tawarruq for investment.
- Conventional finance uses derivatives.

Banking: Islamic banks act as intermediaries between surplus and deficit units in the economic system.
Capital Markets: Long-term debt and equity-backed securities are bought and sold in capital markets.
Risk Protection: Risk management is crucial in the financial system, with conventional methods involving insurance and Takaful (Islamic insurance).

Islamic banking is rooted in Shariah Law, while conventional banking is based on man-made principles.
In Islamic banking, profits are shared between the bank and depositors based on a pre-determined ratio, and profits are not guaranteed.
Conventional banking guarantees depositors a predetermined rate of return.
Islamic banks aim to maximize profits within Shariah and legal restrictions, while conventional banks seek to maximize profits with only legislative restrictions.
Islamic banks participate in partnerships and joint ventures with customers.
Conventional banks lend money with a predetermined interest rate.
The relationship between Islamic banks and customers is based on partnerships, investments, and trading.
The relationship between conventional banks and customers is based on creditors and debtors.
Islamic banking tends to connect with the real economy through trade-related activities.
Conventional banking sees money as a commodity, potentially leading to inflation.
Islamic banking uses money as a medium of exchange and a store of value but not a commodity.
Conventional banking uses money as a commodity, medium of exchange, and store of value.
Islamic banking earns profit through trade of goods or charging for services.
Conventional banking uses time value as the basis for charging interest on capital.
Islamic banking operates on a profit-loss sharing basis.
Conventional banking charges interest even if the customer experiences a loss.

Islamic insurance (Takaful) is based on mutual cooperation and risk-sharing among members.
Conventional insurance is based on the contract between the insurer and the insured.
Takaful uses a pool of funds for covering losses, while conventional insurance relies on premiums.

Islamic capital markets are based on Shariah-compliant transactions and avoid interest-based investments.
Conventional capital markets allow for interest-based financial instruments.
Islamic capital markets focus on real-economy investments and activities.
Conventional capital markets may participate in speculation and other activities that may not align with Islamic principles.