Comparative Analysis of Islamic and Conventional Bank Risk Essay

The decline of the religion has been attributed into modern times with a materialistic culture by the popular wisdom of today, the understanding of religion has embedded this view, as nature having only spiritual limits, and the worldly well being of an individual is very detached in this relation. However, this understanding of Islam religion has been misguided by many of among us in the past, as well as in the present. A critical role has been played by every religion regarding the guidance to survive in a society communally, and in the characterization of different markets of that time. In the religious regards, equal distribution of wealth and debt annulment was preached and emphasized by every religion in the past. The enforcement of the debt bond has been strongly rejected by all the beliefs and the concept of canceling the debt have been upheld by them. In the past, in order to satisfy and fulfill the financial needs of devout and pious Muslims, a concept of money depository was introduced in the Islamic civilization, which has now become a growing phenomenon of the world, that is, around 1. 6 billion Muslims in the world. The macro-economic properties of banking institution have been studies by many economists with relation to an ideal and isolated Islamic economy framework. In modern days, the working of this pioneering financial system is going on very effectively in various parts of the world. In many developed and under-developed countries, the other conventional banking systems are having this unique financing system besides them in every sector of the economy. In this regard, the comparative analysis has been done in this study, which will try to differentiate the Islamic banking system with the Conventional ones. In this study, we will try to understand and clarify the demarcation between the Islamic and Conventional Banking and the risks that are borne by these methods of banking. A financial intermediary having the aims and objectives related to the principles of Islamic law or ‘Shariah’ may be defined as an Islamic Banking System. Consequently, the zero-interest activities and operations are the key features of this distinctive banking system. However, eliminating the transactions based on interest is not the only objective of Islamic banking. The abolishment of all kinds of exploitation is also another aspect of Islamic banking system. In result, a balanced and unbiased social order is established by the system in this regard. Only the role of financier is not played by an Islamic bank. It also works as a partner in the business of an individual. Due to this, the risk between the capital owner and the entrepreneurs is involved by this system. However, the positive result of the collective efforts is also shared by the Islamic banking. Thus, the other conventional banking and interest-based system differs from the Islamic banking, as only the entrepreneur or the owner of the capital bears the risk in the conventional banking, and vice versa. However, the individual and bank shares the abovementioned with each other, which provides the entrepreneur to develop as a whole. In other way, participatory banking name can be given to the Islamic banking in this regard. In the Islamic economics, zero return on capital is not meant by the eliminating process of the interest in this unique banking system, as the pre-determination of a fixed return is forbidden for a certain amount of production in the Islamic laws. The equity based investment principle is followed by the Islamic banks. The contraction of the resources based on deals relating to the sharing of risks, and the ventures of capital is also proposed by the Islamic banking. It has been noted by the economists that economic growth and development of an individual becomes applicable and easy with the vital role that is played by the Islamic banks around the world. We can say that a relationship between finance, commerce, and industry is tried and developed by this exclusive banking system, which differs from the other conventional banking due to these characteristics of its system. The Islamic banking plays its role as an equity-based system, where the pre-determined interest rate is excluded, and the nominal value of deposits is not guaranteed. In result, changing values of the share deposits absorbs the shock to asset position immediately. Therefore, in such system, the assets and liabilities of bank will carry the same real value at all the points. However, in the more traditional and conventional banking system, a diversion can be caused between the real assets and liabilities by such shocks in the process of fixed nominal value of deposits. Therefore, the abovementioned features of this Islamic banking differs it from the traditional and conventional banking system, and so, various levels of risks are borne by these systems. Nowadays, many countries are trying to examine the possibilities of the introduction of an interest-free banking system based on the Islamic laws and principles. It has also been argued and discussed that if the Islamic financial system will be established in the various countries, it will be feasible, but also profitable for the individuals, as well as, the companies as a whole. These days, the truth of interest as an unbearable burden is being realized by the Western countries, as well as, the developing countries around the world. In this regard, all the interests have been waived by the Canada. A similar move has been made by the Australia. The suggestion of waiving off the 30 to 35% of the present interests of the debt has been officially given by the President of France. Therefore, it may be generalized that Islamic Banking and Financing System is a unique and distinctive system, which differs from the conventional banking systems around the world. In order to make a more detailed comparative view of the working and risks borne by the Islamic and Conventional Banking Systems, we will try to analyze with the help of data that represents the comparison between these two financial systems that are applied and practiced around the world. There are some different and diverse characteristics of the abovementioned two banking systems, which should be discussed in order to clarify the comparison between them. In the Islamic Financing system, the number of customers is less than the Marketing-based financing system. The ownership of the Islamic Banking is usually taken by the local or foreign individuals. However, only the local shareholders enjoy the ownership in the conventional banking system. In the Islamic banking, the integration of different activities is very high as compared to the traditional banking system. Lastly, the Islamic financing system has the high intensity of managing and bearing the risk internally, as well as externally. However, the risk is managed and borne by the Marketing-based financing system less internally and externally. Risk sharing is closely related to the risk management; no matter it may be external or internal in its nature. Development of close ties between the customers, and other interest groups may bring the risk externalization by an organization. It has also been indicated by various economists that one contributing factor that is related to the risk management is the long-term relations, which are made on the mutual dependence in an organization. From the different studies related to the Islamic Financing System, the responsibilities are shared by the junior and the senior staff jointly in organizations. In this case, the higher and lower level of management shares the risk. However, in the Marketing-based and Conventional Banking system, the internal risk is shared on a lower basis due to the centralization of power and authority, as compared to the Islamic Banking System. Conclusively, a high degree of the sharing of internal risk is characterized during managing the risk management in the Islamic Banking system as compared to the other conventional financing systems. Therefore, there are many differentiation between the Islamic and Traditional Banking systems around the world. Regarding the risk externalization, in the Islamic Banking system, the close lender-borrower relationships are characterized during the lending activities of organizations. The borrowers are also guided by the Islamic bankers apart from lending funds to them. In result, efficient network relationships create the increment of the externalization of risks relating to the partners who exchange in this regard. Therefore, in the Islamic Financing System, the degree of external risk is observed to be high. However, the formal lenders-borrowers relationships are characterized within the Conventional and Marketing-based financing system. In the result, it is a low degree of externalization of risks in this traditional banking system. In this regard, the extent of success of a banking organization is determined by the lender-borrower relationships, where the customers are given credit in this regard. Direct contacts with the various customers are maintained within the Islamic, as well as, the Conventional Financing Systems. The differentiation is observed in the Islamic Banking System while dealing with the financial activities, as the borrowed funds are monitored closely by these bankers, which results in the higher intensity of the lender-borrower relationships. In this regard, the risks are borne on a higher extent by the Islamic Banking system as compared to the conventional ones. However, the bank gets the higher profit as we have tried to discuss it in the abovementioned matter. Conclusively, the issues of fairness and justice are concerned in the Islamic principles that are related to the interest, rather than defining the efficiency narrowly. The focus is placed on the necessity of sharing the risk in a stable condition with the help of these principles, as well as, at the time of exploitation of the markets. We have also clarified that the Islamic Financing System works on the equity-based projects. However, the conventional ones prefer the debit-based schemes for the lenders and individuals. In an Islamic financing situation, the ownership is shared by the both bank and the client, and in the Conventional banking, all the equity is owned by the client, and the property value plays as a security to the bank loan. We hope that this study will help the scholars and the economists in understanding the role and differentiation of the Islamic & Conventional Banking around the world. Works Cited Ahmad, S. (1992). Towards Interest-Free Banking. New Delhi: International Islamic Publishers. Chapra, M. (2000). The Future of Economics: An Islamic Perspective. Leicester, UK: The Islamic Foundation. Dar, A. H. , and Presley, J. R. (1999). Islamic Finance: A Western Perspective. International Journal of Islamic Financial Services. Dar, A. (2002). Islamic House Financing in the United Kingdom: Problems, Challenges, and Prospects. Ahmad, K. (1994). Elimination of Riba: Concepts and Problems, Response to the Supreme Court Questionnaire. Institute of Policy Studies, Islamabad, Pakistan.