Want to Know About Theories of Motivation

Thories of Motivation

by Shamsul
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Difference Between Islamic Banking and Conventional Banking Model

In the portfolio model of traditional or conventional banks and Islamic banks, Islamic banks tend to invest more resources than traditional banks within economic and commercial transactions. Now, these banks are channeling many resources into the procurement of different treasury bills and other government bonds, which tend to produce a higher rate of return, pose little risk, and carry significant tax benefits.

In Muslim countries, businesses have significantly reduced their dependence upon conventional banks by investing and trading through Murabaha operations and substituting them for costly credit lines, which are allowed to finance their funds. The aspects of Ijara or leasing functions that Islamic banks offer now allow businesses to fund their operations.

Within the conventional banking system, the bank’s role is to obtain funds from external sources and advance those as lending activities, generally long-term, i.e., to function as financial intermediation. The bank derives its income by working with credit and debit interest rates. In contrast, Islamic banking does not make industrial, commercial or agricultural-based transactions (Ayub, 2007).

Interest is strictly prohibited in Islamic banking. This collects funds from savers like the traditional bank, which will be used in different operations. However, these operations are based on the principle of participation or the Sharing of Profits and Losses. From a philosophical point of view, customers can make great partners.

If they are remunerated “depositors,” they should consent to risk sharing of the activities financed with these deposits. If they are “borrowers,” the banking institution will advance funds to them and is a partner in such activities.

When an Islamic bank gets involved in resource allocation (deposits of customers), it will act as a trustee of depositors and principals vis-à-vis active capitalists to whom the funds are advances necessary for a start-up. It, therefore, has a double contractual relationship. Important implications arise from this double contractual relationship of a project (Moucharaka). Despite the resulting conflicts of interest, the bank is the big winner (Hijazi & Hanif, 2010).

In fact, while presuming all risks, depositors will pay management charges to the banks. There will be no guarantee over the fixed amount over their deposits as a traditional bank might do but assumes to pay a particular share of the profit generated or, in case of failing this, to debit them with a share of the losses incurred, if applicable.

In addition, the depositors will not benefit from any insurance that is placed against their deposits and do not have any direct control rights over the choice of investment made on the bank’s part. At the same time, Industrialists, who are also partners and agents, will also get a share in the profits, according to a percentage. In case that project tends to suffer from losses, only the banker and the depositors assume them. The entrepreneur’s risk is limited to wasting time and effort (Zaman, 2010).

To ensure specific control over the project’s activities, the bank, which is also a shareholder, insists on having a seat on the board of directors and imposing specific accounting ratios in terms of management if required. This condition is all the more difficult or even normally unacceptable for depositors since the financial institution might need real power of governance over the managers willing to move one step further from the companies in which it invests. Therefore, the entrepreneur’s choice is critical in the agency relationship, which needs to be developed between the bank and its agent.

Financing through Islamic banks is the regulatory shareholder of investment companies and funds. It is the financial institution that, with the help of these funds, holds the right to oversee firms within which these mutual funds are invested. These investors were not the shareholders and held no voting rights. The investors or depositors do not have control over it (Thorsten, 2007).

The Islamic banking sector, not being lenders within the classic sense of the word, enforces any way the aspect of disciplining corporate executives playing the role of the creditor like that of a commercial bank. This needs to be intervened, for example, when the signs of being defaulted on a loan start to appear. On their part, Islamic banks can intervene only as a shareholder through their presence on the board of directors.

Debt forces executives to act in a manner more consistent with the interests of shareholders. This diagram assumes, of course, that the directors do not hold any shares.


In an Islamic context, however, certain nuances apply.

✔️ Financial markets operating within Islamic nations are not much developed compared to markets operating through corporate control.

✔️ Debt financing is strictly forbidden since all financing should be on the part of the equity or, in other words, leasing or Mudaraba. 

However, it can be seen in a circumstance in which the classic pattern of transforming deposits into loans might be losing its ground; these Islamic banks tend to hold a head start over the conventional banking technique in Muslim nations concerning “security” as well as some products to the investors (depositors).

The lead of Islamic banking is that in addition to the religious and psychological satisfaction that customers derive from them, the profits distributed by Islamic banks are always equal to the interest received by depositors from conventional banks for similar amounts (Choong & Ming-Hua, 2006).

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