What is the difference between Islamic finance & Conventional Finance?

In the past, there are some questions that friends & acquiantances frequently ask me. Aside from the 'So when are you getting married?' question that some people like to ask (which I must say, is an attempt to see me squirm), other questions are somewhat simpler to answer. This includes that question, 'So what's the difference between Islamic finance and non-Islamic/conventional finance?'

Some people may answer by saying, 'In Islamic finance, interest is forbidden'. That is true because without a doubt, interest is forbidden in Islam but with every prohibition in Islam lies a fundamental reason or effect. And one must understand this effect or reason to appreciate the difference between Islamic finance & conventional finance.

My short version in the prohibition of interest is that it's exploitative because it caters for one side to be at a distinct advantage over another. One side will have their money back guaranteed while the other has to sweat and work hard to make sure he can pay back. Is this fair?

(For a detailed macro-outlook on the effects of riba, check out Taqi Usmani's writeup on the prohibition of riba in Pakistan [Note: See p. 42-47).

An interesting scholar, Umar Chapra in, ‘Towards a Just Monetary System’, says that from the Qur’an and the Hadith of Prophet Muhammad, Muslims are given principles to know what is fair and unfair, or what is ‘justified’ and ‘unjustified’, when it comes to one’s earnings. He goes on to say,

“One of the important sources of unjustified earnings is receiving any monetary advantage in a business transaction without giving a just countervalue.”

So my answer to the difference between Islamic finance and conventional finance is that Islamic finance is fair. Islamic finance advocates financial products that provide 'just countervalues'. In other words, Islamic finance aims to get rid of any unjustified or exploitative financial situation, product or service...not just in a loan transaction but in any bits that are unfair or exploitative in the financial world.

The outcome of this simple aim is asset-backed financial products that provide a ‘just countervalue’ for all parties. If you've read Taqi Usmani's book, An Introduction to Islamic Finance, he describes asset-backed financing as financing which creates real assets...which can then be sold for money and consequently, earns a justified profit.

This is very much different from conventional systems that make money out of money (that is 'interest').

In other words, in Islamic finance, there is an asset that creates the profit, not 'Money + Interest = More money' but 'Money + Asset/Real factor of production = More money'.

[Unfortunately, in the past, I've never been able to answer this question in the manner above, whether it's because of the time constraint that we're in (e.g. In the middle of a meeting or tea break) or I couldn't articulate it in the same manner].

After explaining my answer to friends and acquaintances...I normally catch a glimpse in their eyes or their body gesture that says, 'I understand what you're saying but what about the loans that Islamic banks gives out'.

Hmmph. To be honest, the use of Bai Bithaman Aajil (BBA) and Murabaha in Islamic finance especially for loans hasn't helped me in this explanation. This is a controversial concept where perhaps the implementation has been taken lightly in some institutions.

As I've already rambled on here, I will probably probably discuss BBA some other time. However, anyone interested to read up on BBA/Murabaha could read up Justice Taqi Usmani's writeup on the matter (See #6 & 7).

Till next time.