Commercial Banks Versus Islamic Banks

Commercial banks are banks that are profit or interest-oriented. They provide accounts in which customers bank their money for a particular duration and amount after which they are allowed to borrow loans. These loans are to be later repaid with some interest. The savings from the customers also earn interest. Commercial banks are interested in growing the deposit while Islamic banks are not profiting or interest-oriented.

The major aim of the Islamic banks is to provide services to those who believe in the Islamic religion. Islamic banks have a goal of mobilizing resources which are then invested in various sectors of the economy. Islamic banks are meant to act as agents of investments unlike commercial banks which aim at improving the economy. Commercial banks have no clue on how to deal with Zakah while Islamic banks have specialized in Zakah issues in fulfillment of sharia laws (Mahlknecht, 2009).

Commercial banks tend to lay heavy penalties on their defaulters. It is a requirement that one pledges some assets as security before taking up loans from commercial banks. Thus, when they fail to pay their loans and interests the banks can then sell these assets and use the proceeds to compensate both the principal and interest amounts.

Islamic banks on the other hand do not encourage such kinds of actions since no one is required to pledge assets before taking up loans from these banks. There are no heavy punishments imposed on those who fail to pay their loans as this is against the sharia law. These two types of banks also consider different factors before lending money to clients. Commercial banks put more emphasis on the creditworthiness of their customers while Islamic banks evaluate how viable the project their client is to invest in (MacKee et al, 2009).

Commercial banks deny those who fail to pay their loans a chance to access more loans while Islamic banks guide them on how to access more loans and utilize them effectively. Islamic banks are operated according to sharia law which has various restrictions regarding the operation of Islamic banks. For instance, sharia law prohibits these banks from charging interest on the money they lend out, as well as giving interest to customers on their deposits.

Islamic banks differ from commercial banks in many aspects such as the manner in which they prepare financial statements and their modes of operation. These differences are discussed in detail below:

Islamic banks tend to avoid transactions that could lead to the oppression of their customers (Rosly, 2006). For this reason, heavy burdens of interests on the customers are discouraged while commercial banks do not view this as oppression but as a form of income earned through hard work and a way that builds the economy. Hence, what the Islamic banks consider as oppression is seen as a normal way of doing business with commercial banks. Islamic banks discourage one from using the loans they lend them in producing goods that could harm the human race, especially those products that are prohibited by the Holy Koran while for commercial banks although they may follow up their debtors to see how they utilize their money they do not bother what you invest in as long as it is legal (Rosly, 2006).

An asset refers to what a business owns which is a result of a past transaction and can be used to generate income for the business in the future. Banks being businesses also own assets which are usually reported on their balance sheets. These assets are grouped into current and noncurrent assets.

There are differences in the possessions that commercial and Islamic banks have, thus the reason the asset side of the balance sheets of the two banks differ. To clearly bring out the difference we begin with the asset side of commercial banks:

Commercial banks state loans given to their customers as one of their resources. The deposits they make with other commercial banks or the central banks of a country are also reported on the balance sheet as assets. They may also own investments such as the shares of a particular company. Such investments are also reported as assets on the balance sheets of these banks with cash at hand, bills, and securities discounts stated as assets too.

Cars, machinery, and other equipment owned by the bank make up part of the asset side of the balance sheet of commercial banks. Deposits with the central banks of the countries the commercial banks are located also appear on the asset side of their balance sheets while Islamic banks tend to report different assets as explained below:

The loans in original amounts given to customers minus interest are reported as assets by Islamic banks because they do not charge interest on their loans. Investments are also reported as assets; however, they report original amounts unlike commercial banks which base their reports on the current value of the investments. Cash at hand is one of the common assets reported by both Islamic and commercial banks in their balance sheets.

Islamic banks just like commercial banks have vehicles, office machinery, plant, and equipment. These possessions form part of the assets side of their balance sheets. It is recommended that the assets reported by Islamic banks should not be divided into current and non-current assets (Suwaidi, 2006). This is exactly the opposite of what is done on the balance sheets of commercial banks. The investments of commercial banks are reported as one while those of Islamic banks are divided into two categories. The two divisions of investments are Musharabah and Mudarabah investments.

A liability is an obligation that results from a past cash inflow and is likely to cause a future cash outflow from a business. Liabilities can also be defined as what a business owes other people who do not own the business. Most businesses cannot survive minus liabilities.

Commercial banks report various items on the liability side of their balance sheets. Customer deposits are reported on the liabilities’ side of the balance sheet of such banks as they are likely to cause a future flow of cash from the banks. Banks also take loans from other banks and commercial banks report these loans as liabilities. The central banks of the countries in which the commercial banks are located may deposit some cash with these banks which are reported as part of liabilities on their balance sheets.

Islamic banks also report deposits from customers as liabilities. The difference in reporting these deposits is in the amounts reported. Customer deposits in the balance sheets of commercial banks appear in terms of the current value of such deposits while on the balance sheets of Islamic banks they appear in their original amounts (Baamir, 2010).

Deposits from other banks are reported as liabilities by both banks but again the difference is that Islamic banks do not include interests in their figures while commercial banks include. Customers are assured of their deposits in commercial banks while in Islamic banks the clients could as well suffer losses (Suwaidi, 2006).

The liabilities of Islamic banks are usually not divided into long-term and short-term liabilities like commercial banks. Some of the items that appear on the liabilities side of Islamic banks’ balance sheets that do not appear on commercial banks’ balance sheets include Zakah, Salam payables, and Istinaa payables. Commercial banks only report taxes and payables under one heading.

Owner’s equity refers to what the owner of the business has invested in the business while some writers refer to it as the net worth of a business. It is calculated as the assets of the business minus its liabilities. All businesses in the world today have owner’s equity as one of the requirements. Banks are businesses and are thus not exceptional.

Most commercial banks operate as companies with many shareholders who contribute various amounts which are reported as capital under the shareholder’s equity. Transfer to general reserves, ordinary share premium, and profit of the given year are also reported under the equity of the balance sheets of commercial banks. Commercial banks report any money from non-members under liabilities while for Islamic banks such amounts are reported under equity in the unrestricted investment accounts.

Commercial banks make more profits than Islamic banks hence it is likely that owner’s equity may not easily get lost as they tend to work around the clock to make profits and this prevents the likelihood of the banks suffering losses. Thus, the shareholders are sure of their shares and profits. On the other hand, shareholders of Islamic banks are usually doubtful of whether they will receive their shareholdings and profits since the laws that manage Islamic banks discourage profit-oriented activities making the investors of Islamic banks have a higher likelihood of suffering losses (Gup et al, 2004).

The major aim of any business is to make a profit. Profit can be defined as the difference between revenue and all the costs associated with running the business. Banks are businesses and they also aim at making profits. From the discussion above, it is clear that commercial banks make more profits than Islamic banks.

In Islamic banks, there are no charges associated with the services offered while commercial banks use this as one of the avenues for making profits. In commercial banks, some amount is deducted from the customer’s account whenever services are rendered to them. For instance, a customer is charged withdrawing fees when they withdraw money from commercial banks. Ledger fees are also charged on given types of accounts of commercial banks which contribute to their profits.

Commercial banks exploit the interests charged on loans to customers and other banks to improve their profit levels. Customers are usually offered loans with various terms and conditions. The interest rates vary from one type of loan to another; these loans are differentiated from each other based on the duration of repayment and the amount of the loan. The interest rate and the total interest to be paid on a loan given by commercial banks depend on the time taken to service the loan. The longer the repayment period the more interest the loan holder has to pay to the bank.

Commercial banks enjoy giving loans with long repayment periods as they earn more profits from such loans. Investments by commercial banks are also another major way of making profits. The banks buy shares in the capital market and sell them when their prices rise; this brings about a capital gain which contributes to the profit of the bank. Islamic banks on the other hand act as agents of investment for their customers enabling them to make profits from investments (Seznec, 2007).

The costs associated with the revenues generated by commercial banks are many and they may lower the profits of these banks. Some of the costs include the interests they pay to their customers, the interests the commercial banks pay to other banks who have deposited their monies with them, and other hidden costs while the costs associated with revenue generated by Islamic banks are few since the banks neither charge interest nor receive interest from customers. The only costs that Islamic banks incur in their quest to generate income are those associated with the investments they make. This knowledge can make one argue that Islamic banks make more profits than commercial banks.

In conclusion, one can say that commercial banks are better business entities than Islamic banks. The major aim of a business entity is to make profits. When one is choosing a business entity they are advised to go for that one that is likely to earn them more profit. From the above discussion, it is clear that commercial banks make more profits than Islamic banks. Commercial banks may incur more costs in the process of generating revenue. However, the costs exceed the revenues generated due to the clear calculations carried out by accounting officials of commercial banks. These accountants are able to strike a balance between costs and revenues ensuring that the banks earn some profits (Amalendu, 2012).

On the other hand, the limited ways through which Islamic banks make profits make them unattractive business entities. The Islamic banks have fewer costs in the process of generating their revenues but at the same time, they only exploit one avenue when generating revenue hence the little profits earned. Islamic banks however play a major role in society today as they facilitate investments made by the Islamic religion believers since their religion restricts a lot of practices carried out by commercial banks and it would be wrong to go against their religion. Thus, one can say that both Islamic and commercial banks have important roles to play in society today and their existence and operation should be highly encouraged.

There are many commercial and Islamic banks in the world today. An example of a commercial bank in the United Arab Emirates today is the Abu Dhabi commercial bank while a good example of an Islamic bank is the Abu Dhabi Islamic Bank (Seznec, 2007). The Abu Dhabi commercial bank operates as a typical commercial bank since it offers loans at interest and pays interest for the loans it takes up while Abu Dhabi Islamic bank on the other hand operates as per the requirements of sharia law.

References

Amalendu, G. (2012). Managing Risks in Commercial and Retail Banking. New York: Wiley, John & Sons Inc.

Baamir, A. (2010). Shari’a law in commercial and banking arbitration: Law and practice in Saudi Arabia. Farnham, Surrey: Ashgate.

Gup, B., Fraser, D., & Kolari, J. (2004). Commercial Banking: The Management of Risk. New York, NY: Wiley, John & Sons Inc.

MacKee, L., Garner, E., & MacKee, Y. (2009). Accounting services, the Islamic Middle East, and the global economy. Westport, Connecticut: Quorum Books.

Mahlknecht, M. (2009). Islamic Capital Markets and Risk Management. London, UK: Risk Books.

Rosly, S. (2006). Critical Issues on Islamic Banking and Financial Markets: Islamic Economics, Banking and Finance, Investments, Takaful and Financial Planning. London, UK: Author House.

Seznec, F. (2007). The financial markets of the Arabian Gulf. London, UK: Croom Helm.

Suwaidi, A. (2006). Finance of international trade in the Gulf. London, UK: Graham & Trotman.

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