What are the advantages in Islamic Banking?

Islamic banking and financing is not centered only on credit worthiness and ability to repay the loans and interest; instead the worthiness and profitability of a project are the most important criteria of Islamic financing while the ability to repay the loan is sub-segmented under profitability.

One of the unique and salient characteristics of Islamic banks is that the integration of ethical and moral values with its banking operation. The ethical and moral consideration of Islamic banks cannot be detached and their behavior should be consistent with the moral and ethical standards laid down by the Islamic Shari’ah.

Unlike the conventional banks, the financing of Islamic banks are restricted to useful goods and services and refrain from financing alcoholic beverages and tobacco or morally unacceptable services such as casinos and pornography, irrespective of whether or not such goods and services are legal or not in a given country.

In contrast with conventional banks, Islamic banks do not consider only the credit worthiness and interest rate as standards; instead they must apply Islamic moral/ethical criteria in their provision of financing. This adds another merit for Islamic banks since there is a benefiticial impact on the productivity in the economy as it reduces the social and economic cost of such harmful products and activities.

Another important characteristic which forms the basis for the development of Islamic banks is the relationship with depositors. They deal with their customers on investment grounds rather than a pre-determined fixed interest rate. They invest the money of their depositors on high profitable projects after going through a strategic analysis in order to give a substantial return to their depositors.

Thus in Islamic banking industry, each bank will attempt to out-perform other banks if it wants to attract funds from investors. And the ultimate result is that a high return on investments for the investors, which is unlikely in a conventional bank where it deals with their depositors on a pre-determined fixed interest rate.

Furthermore Islamic banks eliminate the barrier between those who save and those who invest, and bring them closer to the real market. The nature of the financial intermediation of Islamic banks significantly defers from conventional banks and it is in harmony with real market and developmental changes in it.

It is important to highlight some of the challenges faced by the Sri Lankan Islamic banks. Although there are many, the most important challenges are the lack of Islamic banking professionals and the lack of Shari’ah scholars who have specialized in Islamic economics. Further the Shari’ah board should have a fair influence on the bank’s operational and strategic planning. For this process to be successful, the Shari’ah boards of our Islamic banks should absorb Islamic scholars based on their technical expertise rather than their popularity.

If you are Muslim, then the advantage would be being able to support a financial institution that abides by Sharia laws. As I understand it, Islamic Finance does not allow the charging of interest on loans. However, they do charge lending fees. In United States GAAP, accountants would look at that lending fee and the time period of the loan, etc. and determine that the fee is actually equivocal to a certain interest rate.