Islamic banks are banks that are based on the principles of Islam. The Islamic religion lays down some practical guidelines for practitioners of the religion to follow. Muslims who run businesses also follow these guidelines in their business management. This brings about differences in terms of how Islamic banks and conventional banks are run. One major difference is that Islamic principles don’t allow banks to offer interest or accept interest. However, Islamic banks have found ways to work around this.
Conventional banks offer interest on deposits their customers have with them. They also offer loans to customers, for which they charge interest. This is a cornerstone of banking. However, Islam prohibits financial institutions from paying or receiving interest. Under Islam, human beings are supposed to cooperate with each other and help each other out. This is why Islamic banks don’t undertake business transactions purely for the interest they would get.
Conventional banks pay customers interests on their deposits, with current accounts earning lower interest rates than longer-term savings accounts. Officially, Islamic banks cannot pay interest on deposits. For instance, The Gulf African Bank, an Islamic bank, doesn’t offer interest on current accounts. However, on longer-term accounts that it calls “investment accounts,” the bank considers the depositor a financing partner, while the bank is the managing partner. This allows the bank to provide a return to the depositor, without calling it interest.
A conventional bank offers mortgage financing that allows customers to buy homes. The customers buy a house and pay interest on the loan they receive from the bank. Since Islam forbids banks to receive interest, Islamic banks don’t offer this sort of straightforward mortgage financing. Instead, the banks buy the house and then rent it to the customer. The customer makes regular payments to the bank and owns the house after making an agreed number of payments.
Banks generally enter into business transactions based on profit motives. They don’t make moral judgments about the nature of the businesses they lend to. Unless there are laws prohibiting certain businesses, they lend for commercial considerations. Conventional banks provide loans to casinos, for instance, that are based on gambling. Islamic law prohibits Islamic banks from lending to certain businesses, such as those based on gambling, intoxicating drugs, pornography or alcohol.