Comparing Islamic Banking and Shariah-Based Banking: Key Differences and Business Models

Islamic banking, also known as Shariah-compliant banking, operates under principles aligned with Islamic law, or Shariah. This form of banking aims to ensure that financial transactions and activities adhere to the ethical guidelines set forth by Islamic jurisprudence. In contrast, non-Muslim dominated banks often offer products that comply with Shariah principles, making Islamic banking accessible to a wider audience. This article delves into the key differences and unique business models of Islamic banking and Shariah-based banking.

Understanding Islamic Banking

At the heart of Islamic banking lies the principle of avoiding Riba, or fixed interest rates, which are prohibited according to Shariah. Consequently, Islamic banks and their customers share risks and profits, or losses, in a manner that is compliant with Islamic principles.

Profit and Loss Sharing

Musharakah involves a partnership agreement in which the Islamic bank and the borrowing entity share both profits and losses. For example, if an Islamic bank lends 50,000 to a businessman, the rate of interest is not fixed but a floating rate based on the profit made. If the businessman expects to make a profit of 30,000, the bank might agree to receive 20% of this profit. This floating rate ensures that the bank’s profit is contingent on the overall business performance.

Key Advantages of Musharakah

The businessman retains full ownership of his capital. The borrower can utilize the borrowed capital immediately after the first installment. It enhances the borrower's ability to earn profits while repaying installments. The bank aids in business planning and guides on the reinvestment of capital. Expenses related to Musharakah are considered operating expenses. The borrowed capital or machinery is not listed as a debt on the borrower’s balance sheet. The bank collaborates with the customer for the maintenance and updating of equipment. A borrower does not need a large capital to acquire expensive machinery.

Mudaraba

Mudaraba involves a venture capital model where the Islamic bank provides the capital, and the entrepreneur uses it to generate income. Both the profits and risks are shared. If the businessman incurs a loss, he would lose the profit he could have earned, while the bank would lose the capital it invested. This system ensures a fair distribution of risk and profit.

Ijariyah

Ijariyah involves the leasing of services or assets to a customer. This concept can include renting factories, machinery, office automation, and motor vehicles for a fixed period. The bank provides these services or assets, and the customer pays a fixed charge or rent for their use.

Qirad: A Further Explanation of Interest Riba in Islam

Under Islamic principles, the concept of interest, or Riba, is not a universal term. It specifically denotes a fixed return on a loan, which is seen as exploitative. In contrast, Islamic banking offers financial products that ensure fair and ethical dealings. While Riba implies a predetermined and fixed return, Islamic finance ensures that returns are tied to business performance.

Shariah-Based Banking: An Overview

Non-Muslim dominated banks that offer Shariah-compliant products are often referred to as Shariah-based banking. These banks adhere to Islamic financial principles while serving a broader customer base. Some global banks like HSBC and Standard Chartered have incorporated Shariah-compliant banking counters to cater to the growing demand for Islamic finance solutions.

Conclusion

The key differences between Islamic banking and Shariah-based banking lie in their adherence to Islamic law and their business models. While Islamic banking focuses on profit-sharing and avoiding Riba, Shariah-based banking offers flexible solutions that comply with Islamic principles while catering to a wider demographic. These differences highlight the importance of understanding the nuances of Islamic finance to effectively navigate the diverse financial landscape.

Keywords: Islamic banking, Shariah-based banking, Mudaraba, Ijarah, Musharakah