Working Model of an Islamic Bank: How different it is from conventional banking
October 3rd, 2017
By Muhammad Ali Shaikh
Islamic Banking being new, there are doubts about its legitimacy. This qualitative study presents a working model of an Islamic bank (IB) and attempts to identify key differences with conventional banks (CBs) that must be maintained along with an interpretation and explanation of the apparent similarities that exist in order to remove confusion.
IBs raise deposits through a Modaraba contract and share, with the depositors, actual profits of the asset portfolio created out of deposits instead of paying interest. The assets so created are either Fixed Income (FI) using trade based or leasing modes or Profit and Loss sharing (PLS) using Modaraba and Musharaka. The basis of intermediation and relationship between parties assigns a new role to IBs as traders, investors or fund managers etc. Instead of credit risk the IB’s financing risk is a mixture of investment and credit risk with some different dimensions such as risk of lower return in case of delayed payments.
The study concludes that the IB model is legitimately a workable model and is distinctly different from conventional model. But there are issues in maintaining the different character of IBs such as partial similarity in product packaging, portfolio structures mostly based on FI income products, financial reporting, legal framework etc. Resolving these issues will improve confidence of the stake holders.