Principles of Islamic banking and finance/PIBF202/Key differences/Overview

The name bank derives from the Italian word banco "desk/bench", used during the Renaissance era by Florentine bankers, who used to carry out their transactions on a desk covered by a green tablecloth. Their present modus operandi is a result of continuous evolution during the last several centuries although traces of some kind of banking could be found in ancient times

Conventional commercial banks are the most important among financial institutions that mediate between those who save from their current income and those who need money for either businesses or consumption. Banks are primary financial intermediaries even if their role is somewhat diminished with the advent of money market mutual funds. They make a profit from the spread between the interest rate they pay on their deposits and the interest rate they charge on their loans.

Commercial banks are heavily regulated by the central bank of every country as their smooth functioning must be guaranteed to avoid any catastrophe in the financial system. Governments have also instituted insurance for bank deposits to provide confidence among bank depositors about the safety of their savings as well as the interest accrued on them. Without the institution of interest, conventional banks cannot function.

On the other hand, as you are already fully aware by now, Islamic scholars almost unanimously regard bank interest as riba strongly prohibited by the Qur’an, the primary source of Islamic law (shari’ah). Islamic banks, therefore, need to devise non-interest deposit and investment products.

In this section, you will learn the differences between the working of conventional commercial banks and Islamic banks. For this it will be appropriate to first know the role and functions of commercial banks in a modern economy and how they operate.