Difference Between Islamic Banking And Conventional Banking

Editorial Note: While we adhere to strict Editorial Integrity, this post may contain references to products from our partners. Here's an explanation for How We Make Money. None of the data and information on this webpage constitutes investment advice according to our Disclaimer.

Islamic banking follows Shariah principles, avoiding interest (Riba), promoting profit and loss sharing, and using asset-backed financing. Conventional banking, on the other hand, charges interest on loans, focuses on profit for shareholders, and involves speculative risk.

Not all banks follow the same principles. As awareness grows, many people are now weighing the differences between Islamic banking and conventional banking to find a system that aligns with their personal values and financial needs. This article explores how the two models differ — examining their foundations, services, and how they affect people’s lives in practical terms.

What is Islamic banking?

Islamic banking isn’t just “interest-free” banking — it’s a fundamentally different worldview of how money should move in society. At its core, it treats money as a facilitator of trade, not a commodity to be traded itself. This flips the logic of traditional banking on its head: where conventional banks profit from lending money at interest, Islamic banks must tie financial activity to something real — goods, services, or outcomes. That’s why every contract in Islamic banking, from Murabaha to Ijara, is designed to reflect genuine economic activity, not abstract financial gains.

Islamic Banking vs Conventional Banking

One of the lesser-known realities of Islamic banking is how deeply it integrates risk-sharing into its DNA. Take Mudarabah and Musharakah — these aren’t loans, they’re partnerships. A bank isn't just handing out funds, it's becoming a co-investor. That means the institution has skin in the game and shares both profit and potential loss with the customer. This model creates a completely different dynamic compared to conventional credit systems, where the borrower shoulders all the pressure regardless of how the venture performs.

So now you must be wondering, how do Islamic banks handle default? While conventional banks escalate interest as a penalty, Islamic banks are prohibited from profiting off delay or hardship. Instead, they may apply deterrents like charitable penalties, where any late fees are donated rather than absorbed as profit. This seemingly small shift reflects a larger moral architecture: Islamic banking isn’t just a financial alternative, it’s a deliberate moral system that tries to align money with justice, real-world value, and shared accountability.

What is conventional banking?

Conventional banking is a profit-oriented model where interest is charged on loans and fixed returns are paid on savings, all with the aim of increasing value for shareholders. These banks operate under secular financial regulations and prioritize generating profits for their investors. They provide loans at set interest rates and earn revenue through mortgages, credit cards, and other lending services.

Interest plays a central role in how conventional banks function. Whether dealing with a personal loan or issuing a corporate bond, the borrower ends up repaying more than they received — usually depending on their creditworthiness, the risk involved, or broader market conditions.

In addition to lending, conventional banks often take part in speculative financial activities like trading derivatives, which can involve considerable risk.

Conventional vs Islamic banking
Features	Islamic banking	Conventional banking
Interest (Riba)	Prohibited	Core component
Risk sharing	Yes	Mostly transferred to borrower
Backed by assets	Yes	Not necessarily
Ethical screening	Yes (per Shariah)	Optional (ESG-based)

Key differences between conventional and Islamic banking

Key differences between Islamic banking and conventional banking

Here are the key differences:

Profit and loss sharing vs interest-based lending

Islamic banks do not charge or pay interest. Instead, they rely on profit-and-loss sharing models such as Mudarabah or Musharakah, where both the bank and the client share in the outcome — whether it’s profit or loss. This creates a partnership built on trust, where both sides are invested in the success of the venture.

In contrast, conventional banks earn a fixed return through interest payments, regardless of whether the borrower succeeds or fails. This structure can put added pressure on borrowers, especially during economic downturns or periods of financial hardship.

Risk-sharing vs risk transfer

Islamic banking is based on the idea that both parties should share risk. For example, when a bank funds a business, it agrees to take on a portion of the potential gain as well as the potential loss. This promotes careful decision-making and encourages fairness between partners.

On the other hand, conventional banks usually shift all the risk onto the borrower. The bank expects to be repaid with interest, regardless of whether the business makes a profit, placing all financial responsibility on one side.

Real assets vs virtual money

Islamic banks focus on financing real economic activity. Every transaction must be tied to a tangible asset — whether it’s property, goods, or services. This approach helps keep the financial system grounded and less vulnerable to speculative bubbles.

Conventional banks, however, often operate in the realm of financial instruments like derivatives and bonds, which may not involve any underlying assets. These transactions can contribute to inflated markets and increase the risk of financial instability.

Gharar (uncertainty) and Maysir (gambling)

Shariah law forbids deals that involve excessive uncertainty (Gharar) or elements of gambling (Maysir). Islamic banks avoid such practices by insisting on clearly defined contract terms and asset-backed transactions that reduce ambiguity and speculation.

In contrast, conventional banks may engage in high-risk financial activities, including futures trading or speculative investment strategies. These practices can increase market volatility and have been linked to financial crises in the past.

Your safest bet for avoiding Maysir and Gharar when trading or investing is by using Shariah-compliant brokers. And luckily, you don’t need to do the hard work here. We have already researched the market and presented the top Shariah-compliant brokers offering Islamic accounts in the table below. You can compare them and make a choice for yourself:

Best brokers that offer Islamic account
	Currency pairs	Min. deposit, $	Regulation	TU overall score	Open an account
Plus500	60	100	FCA, CySEC, MAS, ASIC, FMA, FSA (Seychelles)	6.83	Open an account Your capital is at risk.
Pepperstone	90		ASIC, FCA, DFSA, BaFin, CMA, SCB, CySec	7.17	Open an account Your capital is at risk.
OANDA	68		FSC (BVI), ASIC, IIROC, FCA, CFTC, NFA	6.79	Open an account Your capital is at risk.
FOREX.com	80	100	CIMA, FCA, FSA (Japan), NFA, IIROC, ASIC, CFTC	6.95	Study review
RockGlobal	50	200		1.96	Study review

Ethical screening and social responsibility

Islamic financial institutions apply ethical filters to their investments, avoiding sectors like alcohol, weapons, and gambling. They also incorporate charitable elements, such as zakat and socially responsible finance, to support the broader community.

Most conventional banks do not apply religious or ethical screening to their investments unless they are managing ESG (Environmental, Social, and Governance) portfolios, which are typically offered as niche products rather than core principles.

Products and services: Islamic banking vs conventional banking

Islamic banking products

Islamic banks offer specialized products designed to comply with Shariah principles:

Murabaha (cost-plus financing). The bank purchases a product on behalf of the customer and sells it at a pre-agreed profit, with payment made in instalments over time.
Ijara (leasing). The bank acquires an asset and leases it to the customer, with the option to transfer ownership at the end of the lease term.
Mudarabah (profit-sharing). The bank supplies the capital, while the customer runs the business or project; profits are shared by agreement, while losses are borne solely by the bank.
Musharakah (partnership). Both the bank and the customer contribute capital and share profits and losses based on their respective investment ratios.

Conventional banking products

Conventional banks provide widely used financial services that operate on interest-based systems:

Loans with interest. The bank lends money and charges interest over time, regardless of the borrower’s financial outcome.
Mortgages. These are long-term home loans with either fixed or variable interest rates paid over a set period. While conventional mortgages are not permitted, there are halal mortgages which can be taken.
Credit cards. Customers borrow short-term credit and repay it with high-interest charges, depending on usage and repayment timing.
Savings accounts with fixed interest. Depositors earn guaranteed returns, often tied to central bank rates or other market benchmarks. Explore how Islamic principles apply to Individual Savings Accounts (ISAs), and find out what makes them compliant or questionable.

Products and services: Islamic banking vs conventional banking
Category	Islamic Banking	Conventional Banking
Core Principle	Follows Shariah; prohibits interest (riba) and unethical investments	Based on interest and free-market principles
Product Financing	Murabaha: cost-plus sale with installments	Loans: interest charged regardless of outcomes
Leasing	Ijara: lease with option to buy	Mortgages/Leases: interest-based
Profit Sharing	Mudarabah: bank funds, client manages; shared profits, bank bears loss	Not typically offered; banks don’t share business risk
Partnership	Musharakah: joint investment and risk sharing	Rarely practiced
Credit Cards	Permissible only if interest-free	Interest charged on usage and late payments
Savings Accounts	Profit-sharing basis, no guaranteed return	Fixed interest returns
Mortgages	Offered via halal structures (Murabaha/Ijara)	Interest-based home loans

Regulatory and operational differences

Shariah boards and religious guidance

Every Islamic bank works with a Shariah board — a panel of Islamic scholars responsible for reviewing and approving all products and services. Their role is to ensure the bank operates in full compliance with Islamic legal and ethical principles.

Role of central banks

Islamic banks, like conventional ones, fall under the regulation of central banks in their home countries. But unlike conventional banks, they must also adhere to religious standards, which often brings added layers of oversight.

Global adoption and growth

Islamic banking continues to grow at a strong pace in markets like Malaysia, Saudi Arabia, and Indonesia. Its appeal is also expanding into non-Muslim countries that are looking for alternative financial models.

Risk-sharing, not just interest avoidance, defines the core edge of Islamic banking

What most people overlook is that the real difference between Islamic and conventional banking isn’t just about avoiding interest — it’s about how risk is treated and shared. In conventional banking, clients are typically borrowers, and risk rests almost entirely with them. The bank gets paid whether you succeed or not. In contrast, Islamic banking is built around profit-and-loss sharing contracts, like mudarabah and musharakah, where both the bank and the customer are financially exposed.

That means Islamic banks aren’t just passive lenders — they become active stakeholders in the success of their clients. This risk-sharing structure forces more due diligence, encourages long-term partnerships, and often results in more responsible financing decisions.

Another key insight? Islamic banking tends to evaluate the moral utility of a business before financing it — not just the return potential. Conventional banks may look at numbers; Islamic banks also ask if the underlying activity adds value without violating ethical norms (e.g., no alcohol, gambling, or speculative instruments).

This means Islamic financial institutions are more selective in deal structuring, often leading to a cleaner asset book. For a beginner, this translates into a system where the alignment between investor values and financial performance is far stronger — one that filters out high-risk, ethically questionable ventures before they even enter the pipeline.

Conclusion

While both models provide financial services, the way they manage risk and define success couldn’t be more different. Islamic banking’s strength lies in how it ties money to real assets, filters out harmful industries, and holds both parties accountable in a deal. It’s not just about avoiding interest — it’s about building a system that promotes shared responsibility and long-term trust. For anyone looking beyond profits, this approach offers a way to stay financially active without compromising personal or ethical beliefs.

FAQs

How do Islamic banks handle inflation if they can’t charge interest?

Islamic banks often use fixed-profit contracts like Murabaha to manage inflation. Instead of adjusting interest rates, they agree on a set markup at the time of sale. This locks in the cost regardless of inflation but requires careful pricing upfront to avoid losses.

Can Islamic banks invest in cryptocurrencies?

It depends on how the cryptocurrency is used. If it's seen as a speculative asset (like gambling or uncertain bets), it’s typically not allowed. But if used for legitimate trade or as a store of value, some scholars are open to its use — though opinions still vary widely.

Are Islamic banks insured like conventional banks?

Yes, many Islamic banks are part of national deposit insurance schemes. Some countries even offer Shariah-compliant versions of deposit protection. The key is ensuring the insurance model itself doesn’t involve interest-based or speculative practices.

Why don’t Islamic banks offer credit cards like conventional banks?

They actually do — but with a twist. Islamic credit cards avoid interest charges and instead apply fixed fees or profit-based repayment models. They're structured to stay within Shariah rules, often using contracts like Ujrah (fee-based service) or Tawarruq (buy-sell arrangements) instead of charging interest.

Team that worked on the article

Alamin Morshed is a contributor at Traders Union. He specializes in writing articles for businesses that want to improve their Google search rankings to compete with their competition. With expertise in search engine optimization (SEO) and content marketing, he ensures his work is both informative and impactful.

Learn about our editorial policies

Chinmay Soni is a financial analyst with more than 5 years of experience in working with stocks, Forex, derivatives, and other assets. As a founder of a boutique research firm and an active researcher, he covers various industries and fields, providing insights backed by statistical data. He is also an educator in the field of finance and technology.

As an author for Traders Union, he contributes his deep analytical insights on various topics, taking into account various aspects.

Mirjan Hipolito is a journalist and news editor at Traders Union. She is an expert crypto writer with five years of experience in the financial markets. Her specialties are daily market news, price predictions, and Initial Coin Offerings (ICO).

Broker

A broker is a legal entity or individual that performs as an intermediary when making trades in the financial markets. Private investors cannot trade without a broker, since only brokers can execute trades on the exchanges.

Trading

Trading involves the act of buying and selling financial assets like stocks, currencies, or commodities with the intention of profiting from market price fluctuations. Traders employ various strategies, analysis techniques, and risk management practices to make informed decisions and optimize their chances of success in the financial markets.

Volatility

Volatility refers to the degree of variation or fluctuation in the price or value of a financial asset, such as stocks, bonds, or cryptocurrencies, over a period of time. Higher volatility indicates that an asset's price is experiencing more significant and rapid price swings, while lower volatility suggests relatively stable and gradual price movements.

Investor

An investor is an individual, who invests money in an asset with the expectation that its value would appreciate in the future. The asset can be anything, including a bond, debenture, mutual fund, equity, gold, silver, exchange-traded funds (ETFs), and real-estate property.

Cryptocurrency

Cryptocurrency is a type of digital or virtual currency that relies on cryptography for security. Unlike traditional currencies issued by governments (fiat currencies), cryptocurrencies operate on decentralized networks, typically based on blockchain technology.