Islamic Banks Vs Conventional Banks Essay

Literature Review

The comparison between Islamic and conventional banks as stated by Zaharuddin (2007) and Ariff (1988) as below:

Conventional Banks Islamic Banks

The operating modes and functions are based on fully manmade principles. The operating modes and functions are based on the principles of Islamic Shariah.

The investor is guaranteed of a predetermined rate of interest. Risk sharing between provider of capital and the user of funds is promoted.

Its goal is to maximize profit without any restrictions. Its goal also is to maximize profit but subject to Shariah compliances.

It does not deal with Zakat. It is a Zakat Collection Centre and they have to pay out their Zakat.

The fundamental function of the banks is to lend money and get

On the other hand, Islamic banks which give the lower agency problems might have lower monitoring and screening costs. There are no significant differences in business orientation between conventional and Islamic banks. The Islamic banks are less cost-effective and more conservative approach to risk-taking than conventional banks. The variation with the difference in intermediation ratio, cost efficiency, asset quality and capital-asset ratios between both banks is partly due to the difference in market share of Islamic banks. The Islamic banks have a relatively better stock market performance and are less likely to disintermediate during the latest crisis as they are better capitalized and asset

(2005) only measured cost and technical efficiency of conventional banks. It is not possible to generalize their findings as conventional banks and Islamic banks are two different entities and are operating in different economic environment and banking systems. The concept of production efficiency originated from Cobb and Douglas (1928). Berger and Humphrey (1997) extended the Cobb-Douglas model to the banking sector by focusing mainly on financial sector efficiency. This is because financial sector emphasizes that fostering productivity, there has to be an efficient allocations of financial resources. The performance comparison between domestic and foreign banks has to be included in the analysis so that there would be sufficient scope and on level ground to compare findings of conventional bank and Islamic banks in terms of productivity efficiency. Nonetheless, the results imply that Islamic banks are more effective in achieving higher efficiency in the presence of close competition pose by the conventional