Compare and Contrast between Islamic and Conventional Banking Term Paper

Compare and Contrast between Islamic and Conventional Banking - Term Paper Example Yet, riba or interest is not precisely defined in the Quran at the time of its prohibition. The prohibition of interest is generally understood to refer to any increment over and above the principal. It represents the return on transactions involving exchange of money for money, or an addition, because of delay in payment, to the agreed price on sale debts/debts. From an Islamic point of view under some concept of fairness, there are two dimensions: the supplier of capital possesses a right to reward, but this reward should be commensurate with the risk and effort involved and should be determined by the return realized on the individual project for which funds are supplied (Abdi, 2010, p 80). One of the primary rationales espoused by Muslim scholars is that the existence of riba (interest) in the economy is a form of economic exploitation, which violates the core Islamic teaching of social justice. Therefore, the elimination of interest from the economic system would be more â€Å" fair† and ethically and morally more appropriate economic behavior. The prohibition of interest (riba) and permission of trade drive the financial activities in an economy towards asset-backed businesses and transactions. This implies that all financial transactions must be representative of real transactions for the sale of goods, services or benefits (Abdi, 2010, p 81). Interest-free loans (alternative for usury) Islamic financial institutions must not only focusing on maximizing profit, but they should also play a vital role in addressing socio-economic issues such as poverty reduction and improvements in important aspects of human welfare (like education, illiteracy, reducing child mortality, youth insecurity and...Generally, equity financing under non-Islamic finance, savers would provide funds to enterprises in return for a share in its prospective net returns as well as a share in its management. However, in contrast, profit sharing funding of projects under Islamic fin ance is not for the whole life of the financed enterprise, but for a shorter period, as in the case of providing working capital. Profit sharing finance may be provided with and without sharing in management, Linked with profit sharing is the notion of risk sharing. This is based on the principle of liability, which states that profit is justified based on one’s obligation to take a loss. This legal maxim is said to be derived from a saying of the Prophet Mohammed that â€Å"profit comes with liability† implying that Shari’a distinguishes lawful profit from all other forms of gain. One becomes entitled to profit only after one bears the liability, or risk, of loss. Tax in Islamic banking (Zakat) Zakat- This is the requirement to benefit society through the collection of alms, which is known as Zakat Benefits Zakat For society, fractional reserve system allows banks to act as intermediaries that facilitate the movement of funds from savers to investors in a society. There are also significant economies-of-scale in banks making investment and lending decisions, as they have access to knowledge and expertise which individual investors or lenders generally do not.