Comparison between Islamic and Conventional Bank in UAE: Detailed Overview

By Sakshi Srivastava - 16 Oct 2021 Last Updated: 01 Dec 2021
Comparison between Islamic and Conventional Bank in UAE: Detailed Overview

The performance of every economy's banking sector has a significant impact on its growth. The banking industry serves as a conduit between two parties: those who provide funds and those who invest those monies for productive purposes, thereby contributing to economic growth. There are two types of banks in the financial sector. One type is known as conventional banks, while the other is known as Islamic banks. The primary distinction between the two bank types is the ideology upon which the banking industry is founded. Interest rates are completely prohibited in the Islamic banking industry, regardless of how tiny or huge they are. As a result, it is sometimes referred to as interest-free banking. Conventional banks, on the other hand, are entirely based on interest. As a result, they are known as interest-based banks.

Globally, the banking sector has developed in its products over time to meet evolving consumer demands. The religious beliefs of the people were one of the key factors of this transition, resulting in the extraordinary rise of the Islamic Banking System. These banks predominate in countries with considerable Muslim populations, such as Iran, Pakistan, and Sudan, but are not limited to them. The main distinction between an Islamic and a conventional bank is the structure and principles that govern them. Islamic banking institutions are governed by Sharia, or Islamic law. The Quran, Islam's sacred book, forbids any transactions from receiving and paying interest, known as Riba, because interest-bearing credit structures are thought to lead to an unequal distribution of social income. Profit sharing agreements are used by Islamic banks to overcome this difficulty. Under the Islamic banking paradigm, the notion of interest is reconstructed with a time markup of payments and commercial financing commissions.

Nowadays, Islamic banks and conventional banks are working together in a dual regulatory environment and there is an intense competition between them in attracting potential customers and fulfilling their expectations and developing new instruments and modes of financing which in turn benefits the economy in the long-term.

The United Arab Emirates (UAE) gives Islamic banking more attention and support. For example, Dubai Emirate is aiming to establish itself as a global hub for Islamic finance. The UAE government's strategic plan 2021 encourages the growth of the Islamic banking industry (Emirates Diary, 2015). In the UAE, there are now twenty-three local banks and twenty-two international banks in operation. Five of the twenty-three local banks are fully-fledged Islamic banks operating following Islamic norms, while the others operate in both traditional and Islamic modes (Emirates Diary, 2015).

Let’s Understand the Islamic Financial System

The prohibition of RIBA (usury), which is any return/addition/increase for the use/rent of money, is one of the most significant contrasts between conventional and Islamic banking. Islamic financial organisations must "exchange" actual assets or services in order to be considered Islamic.

There are various grounds for the ban of riba, including the fact that it is unjust; a contract based on interest is unfair to one of the parties, either the lender or the borrower. Penalizing someone for default is unjust; the amount of any compensation for a default should be decided by a judge, not the party to whom the obligation is owed. "Taking a sum in excess of the primary would be unfair," according to the Qur'an (2:279). Interest on money is seen as an unwarranted formation of instantaneous property rights, and it implies unlawful appropriation of other people's property. Interest is a property right claimed outside the legitimate context of recognised property rights; hence it is unjustifiable.

Difference between Islamic Banks and Conventional Banks

There are several significant distinctions in how conventional and Islamic banks operate. Conventional banks in the UAE have embraced accounting procedures based on the International Accounting Standards Board (IASB) and International Financial Reporting Standards (IFRS) standards (Hussainetal.,2002). Islamic banks, on the other hand, adhere to the Accounting and Auditing Organization for Islamic Financial Institutions' accounting policies (AAOFI). Each Islamic bank sets a Sharia committee to oversee and review all bank transactions to ensure that they are conducted in accordance with Islamic standards.

While most people are aware of the interest-bearing loan and what it entails, traditional deposit-forming assets and liabilities. On the liability side of an Islamic bank balance sheet, banks qard hassan is included on the sheet, which has been opened for saving account. On the website, you may also start a savings account. Mudaraba or Musharaka ideals serve as the foundation. As part of the project, Islamic banks have three different types of assets. Islamic financing modes come in a variety of shapes and sizes.

  • Sale based methods which include i.e., Istisna, Murabaha and Salam.
  •  Products that offer profit sharing participatory methods like Mudaraba, Musharaka and Diminishing Musharaka.
  • Islamic leasing product called Ijara.

As a result, the products supplied by regular banks and Islamic banks differ significantly. The UAE is home to the world's oldest Islamic bank, Dubai Islamic Bank, which began operations in 1979. There are seven full-fledged Islamic banks as of 2018, with several conventional banks additionally operating an Islamic window. CBUAE, FSR [2] said that Islamic banks accounted for 23% of total assets among UAE national banks, while conventional banks accounted for 77%. Dubai was preparing to become a major Islamic finance hub as it tried to exploit the sector's vast potential, with global Islamic finance assets expected to exceed USD 3 trillion by 2018. However, according to a research published by S&P Global Rating, Islamic assets increased by only 2% in 2018 compared to 10% in 2017, due to a drop in sukuk demand. Because of low oil prices and geopolitical risk, the Middle East markets have declined, and the Islamic banking industry is likely to grow slowly.

Why UAE residents prefer Sharia Banks over Conventional Bank for loan?

Despite a drop in overall penetration due to the ongoing economic circumstances caused by the coronavirus pandemic, Islamic banks in the UAE continue to outperform their conventional counterparts in personal finance products such as loans, auto loans, and mortgages.

Muslims and non-Muslims alike believe that Shariah-compliant banks are more honest when it comes to payment delays and late fees. Furthermore, they are not as prohibitive. Even in the perception index, Islamic banks are thought to be more trustworthy in terms of price. Better rates and price are cited as a factor influencing a prospective change to Islamic financial products by respondents, both Muslim and non-Muslim, ahead of better customer service, better technology, and a wider product selection, showing the high premium consumers place on value.

According to the index, overall penetration of both conventional and Islamic banking fell slightly in 2020, from 60% to 58 percent for Islamic banking and from 65 percent to 64 percent for conventional banking, compared to 2019. In 2020, overall penetration of both conventional and Islamic banking declined slightly, from 60% to 58 percent for Islamic banking and from 65 percent to 64 percent for conventional banking, according to the index, compared to 2019.

Overall, Muslim respondents used Islamic financing products at a constant rate of 70% in 2019 and 69 percent in 2020. The number of non-Muslims using Islamic credit cards increased from 24% in 2019 to 28% in 2020, and the number of non-Muslims using Islamic savings accounts increased from 28% to 32%.

Conclusion

The majority of the study focuses on the dynamic variations in bank performance between Islamic and conventional banking. Regardless of the time, country, or performance measure, conventional banks outperform their Islamic equivalents, according to the various regression models. Furthermore, there are differences in the direct determinants of success between the two banking models. Liquidity, for example, appears to affect the performance of conventional banks, but it does not appear to be a feature in Islamic banks' performance function.

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By Sakshi Srivastava

16-Oct, 2021

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