by Hadia Zaid
Often misconceived as merely conventional banking under a different guise, Islamic banking is a distinct financial system founded on ethical principles derived from Islamic law (Shariah). Over the past few decades, this system has witnessed remarkable growth in Pakistan and many other Muslim-majority countries, becoming a key player in their financial landscapes. However, critics frequently argue that Islamic banking resembles conventional banking in practice, prompting the critical question: is Islamic banking truly unique, or is it simply conventional banking repackaged in religious terms?
The philosophy behind Islamic banking
Islamic banking is fundamentally rooted in the principles of Shariah, the moral and legal framework of Islam. Shariah strictly prohibits riba (interest), gharar (excessive uncertainty), and investments in haram (forbidden) activities. Instead of generating income through interest, Islamic banks rely on profit-and-loss sharing models, such as Mudarabah, where the bank shares in the profits or losses of the borrower’s business ventures.
In theory, these principles distinctly separate Islamic banking from conventional banking, which primarily operates on an interest-based model. Unlike Islamic banks, conventional institutions extend loans with interest charged regardless of the borrower’s financial outcomes.
Islamic Banking: beyond mere terminology
The notion that Islamic banking is simply conventional banking rebranded with Islamic terminology overlooks the fundamental differences in their operational frameworks. Unlike conventional banks, which shift the entire risk burden onto the borrower by charging interest regardless of the venture’s outcome, Islamic banking emphasizes risk-sharing. The bank’s profits are directly tied to the actual performance of the investment, fostering a more equitable partnership between the bank and its clients.
Conventional banking relies on fixed interest rates for loans, often adding financial pressure on borrowers, especially during periods of economic instability. In contrast, Islamic banking structures transactions to ensure that both parties share the risks and rewards, promoting greater financial stability and a collaborative spirit.
Two key features that distinguish Islamic banking are its reliance on asset-based financing and its commitment to risk-sharing, both of which reinforce its ethical and community-focused approach.
Asset-based financing (Murabaha): Islamic banking transactions are inherently tied to tangible assets. For instance, in contracts like Murabaha (cost-plus financing), the bank purchases an asset and sells it to the customer at an agreed-upon profit margin, rather than simply lending money with interest. This asset-backed approach ensures that Islamic banks remain directly connected to real economic activities, distinguishing them from the speculative financial practices often prevalent in conventional banking.
Islamic banks in Pakistan
Pakistan’s financial sector has witnessed remarkable growth in Islamic banking, with Meezan Bank, Al Baraka Bank, and Bank Islami leading the way in providing fully Shariah-compliant services.
A standout example of this transformation is Faysal Bank, which has evolved from a conventional bank to a fully Islamic banking model. By December 2024, Faysal Bank is expected to operate an impressive network of 855 branches across Pakistan, underscoring its commitment to aligning with Shariah-compliant principles.
This transformation is more than a rebranding effort; it reflects the essence of Islamic banking as a holistic financial system designed to uphold justice, transparency, and financial stability—values that conventional banking often struggles to match.
For Islamic banking to sustain its momentum, it must continue balancing strict adherence to Shariah principles with commercial viability while clearly distinguishing itself from conventional banking practices.
Hadia Zaid is a freelance contributor