Difference between Islamic and Conventional Systems

“Economic and Banking Perspective”

Course Title: Islamic Banking

Submitted to: Mr. Shoaib Qureshi

By: Annum Javaid

Class: BBA 2K6

May 18, 2010

Persian philosopher Nasir al-Din al-Tusi (1201–1274) presents an early definition of economics as:
"the study of universal laws governing the public interest (welfare?) in so far as they are directed,
through cooperation, toward the optimal (perfection)."

ISLAMIC ECONOMIC SYSTEM

FOUNDATIONS OF AN ISLAMIC SYSTEM

An Islamic economic system is based on the following core values.

1. Need Fulfillment. - assure everyone a standard of living that is humane and respectable.
2. Respectable source of earning. - Need fulfillment must be through individuals own effort.
3. Equitable distribution of income and wealth. – Money should not only circulate among
the rich.
4. Growth and stability.  

IMPORTANT INSTITUTION OF ISLAMIC ECONOMIC SYSTEM

Most important institution of Islamic economic system are:

 Private ownership
 The system of zakat and usher
 Khamas and kharaj
 Law of inheritance
 Spending and sadqat
 Sharakat and mazarbat
 Rule and regulation of commercial dealing
 Prohibition of interest and gambling
 State responsibility of providing necessities of life

CHARACTERISTICS OF ISLAMIC ECONOMIES

The Islamic economic system are marked by firstly achievement of social welfare. Economic
development and poverty elimination is another attribute. This is done by employing means for
security of income, participation for all in the democratic process, social cohesion, cultural
enrichment and sustainable development for future generations. Thirdly to equalize distribution
of wealth, by means such as Zakat and Sadqat. Fourth is elimination of waste. Extravagance and
waste are strongly discouraged. "[The Servants of Allah are] Those who, when they spend,
are not extravagant and not stingy, but hold a just balance between those extremes."
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(25:67).Another purpose of Islamic economic system is to adopt a course of economic struggle
which does not curb the freedom of thought and action of the individual.

CAPITALISM

The term capitalism was first introduced in the mid-19th century by Karl Marx. It can be simply
defined as an economic system, marked by open competition in a free market, in which the means
of production and distribution are privately or corporately owned and development is
proportionate to increasing accumulation and reinvestment of profits.

PHILOSOPHICAL FOUNDATIONS OF CAPITAL SYSTEM

1. Materialism - The center and the focus of man’s struggle should be the satisfaction of
material needs.
2. Liberalism - The individuals have complete freedom of thoughts and action in every sphere
of life.
3. Hedonism - The entire struggle of the individual has only one goal personal interest.

CHARACTERISTICS OF CAPITALIST ECONOMIES

A set of broad characteristics are generally agreed on by both advocates and critics of capitalism
encompass private property rights which is private ownership of the means of production. Second
is free market, where all economic decisions regarding transfers of money, goods, and services
take place on a voluntary basis, free of coercive influence. The pursuit and realization of profit is
another essential characteristic of capitalism. In context of capitalism many writers, such as Adam
Smith and Ayn Rand, point to what they believe to be the benefit of individuals trading for their
self-interest rather than altruistically attempting to serve the "public good." Free enterprise; in
capitalist economies, a predominant proportion of productive capacity has belonged to
companies, in the sense of for-profit organizations. One of the primary objectives in a social
system in which commerce and property have a central role is to promote the growth of capital.
Last is the existence of large changes in the make-up of its socio-economic strata which is termed
as economic mobility.

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SOCIALISM

Socialism or communism means an economic system in which the means of production are owned
by the state.

PHILOSOPHICAL FOUNDATIONS OF SOCIALISM

1. Materialistic Interruption of History - The large scale modes of production and factory
system created by modern capitalism has led to the formation of labour unions and
increase the collective strength of workers. This strength of the workers will strike a death
blow to capitalism and establish socialism.
2. Theory of Surplus Value - In the capitalism system a large portion of profit is expropriated
by the capitalist. This injustice can only be removed in the system of collective ownership.
3. Class War - This system decreases the number of capitalists and constantly grows workers
strata day by day. Hence it is the workers who will be victorious in this war and a classless
society dominated by workers will replace the modern capitalist system.
4. Dictatorship of the Proletariat - The authority to exercise the power lies with the state.

CHARACTERISTICS OF SOCIALIST ECONOMIES

Characteristics of socialism include mainly abolition of private property and collective ownership
of means of production. Central planning which deals with the forces of demand and supply are
balances by central planning and a balance is not affected by price mechanism is another one.
Socialism is also marked by elimination of unfair gaps in incomes. In this system state ensure that
work is extracted from each individual according to his capacity and compensation is given to him
to supply all his needs. The state provisions necessaries of life.

COMPARISON BETWEEN ISLAMIC ECONOMIC SYSTEM

AND OTHER ECONOMIC SYSTEMS

DIFFERENCE BETWEEN ISLAM AND CAPITALISM

Both recognize the right of private ownership of necessaries of life and the means of production.
There is difference between concept of ownership given by Islam and Capitalism. According to
Islam All kind of property are Allah’s trust with the individuals this interest can only be obtained

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with Allah’s will. Islam does not recognize the right of the individual to own a property which he
has gained by those means which shariat declares unlawful.

Capitalism recognizes absolute right of the individual to own and utilize his property. This opens
the door to all the evils like economic inequality, injustice distribution of wealth and class conflicts.

Interest is the backbone of capitalism. The creation and formation of capital and professional
activity depends on it. Islam proscribes interest. So the rise of major and blood- sucking usurious
monsters has been stopped forever.

The capitalism economy by nature tends to unjust wealth distribution. In this system individuals
exercise their freedom to rapidly establish their economic monopolies.

Taxes can be imposed only up to the limit. Moreover the capitalism class generally resorts to
tactics of tax-evasion. Islam discourages all those means of earning wealth which leads to the rise
of economic monopolies. Islam ensures the circulation and equitable distribution of wealth among
all classes of society by establishing a regular system of Zakat, sadqat and the law of inheritance.

DIFFERENCE BETWEEN ISLAM AND COMMUNIST SYSTEM

There is the difference between fundamental viewpoints of both systems. The communist system
is the child of materialism. It regards material need as the only real needs of man. Hence man
should struggle to satisfy these needs. Islam presents the concept of higher world which is above
this material world. This higher world is permanent and everlasting.

The basic concept of the communist economy is to abolish private ownership and establish
collective ownership of means of production. All means of production are taken under state
control. Multitude of capitalists is replaced by only one big capitalist. Islam has no doubt that
collective ownership of means and production and state management of distribution of goods and
services ensures the supply of necessities of life to individual citizens but for this gain they loss
their natural blessing of free thoughts and actions.

Production targets are set in advance and then measures are taken to achieve those targets by
force. Islam has kept the natural profit motive alive among the individuals so that they may have
full opportunity to exercise their intellectual talent, capacities and energies. Where the profit
motive oversteps its lawful bounds, automatic checks are ready to keep it on the right track.

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DIFFERENCE BETWEEN CONVENTIONAL BANKS & ISLAMIC BANKS

Basic guidelines governing ideology of an Islamic bank are Riba, Zulm, Gharar, Zakat and Haram.

Islamic finance differs from conventional banking on the following mentioned grounds.

1. Principles

The functions and operating modes of conventional banks are based on fully manmade principles.
In Islamic systems, Islamic Shari’ah governs all the actions and operations.

2. Usury (Surplus)

The investor is assured of a predetermined rate of interest in conventional system. In contrast,

Islamic finance it promotes risk sharing between provider of capital (investor) and the user of
funds (entrepreneur).

3. Restrictions over Profit Maximization

Conventional banking aims at maximizing profit without any restriction. However in Islamic
context profit maximization is subject to Shari’ah restrictions.

4. Purpose

Lending money and getting it back with compounding interest is the fundamental function of the
conventional banks. On the other side Islamic finance is oriented toward involvement in
partnership business resulting in good understanding of customer’s business.

5. Default Penalty

Conventional banks charge additional money (penalty and compounded interest) in case of
default. This gives rise to injustice. The Islamic banks have no provision to charge any extra money
from the defaulters. Only small amount of compensation and these proceeds is given to charity.

6. Social Welfare

On the basis of social welfare operations of conventional banks often results in the bank’s own
concerns becoming prominent. It makes no effort to ensure growth with equity. Contrast to that
Islamic systems give due importance to the public interest. Its ultimate aim is to ensure growth
with equity.

7. Borrowing

For interest-based commercial banks, borrowing from the money market is relatively easier. For
the Islamic banks, it must be based on a Shari’ah approved underlying transaction for instance
there should not be any Riba Qardh and Riba Jahilliyah.

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 8. Project Appraisal

Since income from the advances is fixed in conventional banking; therefore it gives little
importance to developing expertise in project appraisal and evaluations. Islamic banks since share
profit and loss, therefore they pay greater attention to developing project appraisal and
evaluations.

9. Credit Worthiness vs. Viability of Project

Conventional banks give greater emphasis on credit-worthiness of the clients. Yet feasibility of the
projects is more central to Islamic banks.

10. Bank’s Relation

The status of a conventional bank, in relation to its clients, is that of creditor and debtors. But
Islamic bank relation to its clients is that of partners, investors and trader, buyer and seller with its
stakes involved.

11. Guarantee

A conventional bank has to guarantee all its deposits. In case of Islamic bank, it can only guarantee
deposits for deposit account, which is based on the principle of al-wadiah, thus the depositors are
guaranteed repayment of their funds, however if the account is based on the Mudarabah concept,
client have to share in a loss position.

12. Risk Involvement

Islamic guidelines say that there is no right of profit if there is no risk involved and there is
equitable distribution of risks and rewards among the stakeholders. But conventional banking is
almost risk free and depositor has no risk of losing its money because interest is guaranteed.

13. Asset-based financing

Islamic banking encourages asset-based financing and based on commodity trading. Conversely
conventional system is based on money trading. Money is a medium of exchange and not a
commodity, its sale and purchase is prohibited in Islam.

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 14. Up and Downside of Investment

Conventional banking has limited upside and unlimited downside of an investment. On the other
side Islamic finance offers unlimited profit opportunity of the investment and the downside is only
limited to the level individual’s level of investment.

15. Rate of Return on Deposits

In Islamic banking rate of return on deposits is uncertain and unguaranteed. Conventional banking
works exactly in opposite to this with predetermined rate of return.

16. Products and Services

Islamic Bank Conventional Bank

Musharaka, mudaraba, murabaha, salam, Deposits, lockers, micro finance, consumer
istasna, ijarah, diminishing musharak and loans, working capital need solutions and debt
takaful  financing

REFERENCES

 http://www.meezanbank.com/section1_2.aspx
 http://www.trcb.com/religion/islam/islamic-economic-system-5951.htm
 http://www.islamic-life.com/forums/islamic-finance-banking/difference-capitalist-
communist-islamic-economic-system-2398
 Jomo K.S. (1993) “Islamic Economic Alternatives”, Ikraq Publications.
 Sheikh Ghazali Sheikh Abod, Syed Omar Syed Agil, Aidit Hj. Ghazali, (2005) “An Introduction
to Islamic Economics & Finance”, CERT Publications.
 http://www.scribd.com/doc/19653430/Islamic-Economic-System-Capitalism-and-Socialism
 http://www.islamic-banking.com/early-muslim-thinkers.aspx