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Paying the Price:

Conventional
versus Islamic
As Islamic finance steadily gains prominence in the global financial
scene, never-ending debates have sprouted on whether Shariah or
conventional banking products would provide more value for money.
ANNA MARIA SAMSUDIN finds out whether pricing should be the
main determining factor when choosing between the two.
“Which are cheaper — conventional or Islamic products?” is are cheaper than conventional (ones). Price competitiveness
probably the question uppermost in the minds of consumers will depend on various factors,” the observer noted.
when trying to decide which would meet their financing
needs. However, many financial experts believe that price In the case of basic home financing, Islamic products under
comparison alone would not be an accurate indicator as the Bai Bithaman Ajil (BBA) structure, which is deferred
each model has its own appeal and should be viewed in payment sale, might offer more competitive deals than
totality. At the end of the day, decisions should be made conventional banking. In comparing the two models, Bank
based on the investor’s risk appetite. Negara Malaysia, on its website, explains an ordinary
conventional housing loan is based on debtor-creditor
One Singapore-based market observer points out that relationship and the interest rate charged is based on a
theoretically, prohibition on riba or interest (one of the certain percentage above the base lending rate over loan
pillars of Islamic banking) already renders Shariah financing period. Fluctuation in the base lending rate will affect total
cheaper than conventional products. loan cost. Simultaneously, arrears in conventional loans are
normally capitalized.
In the olden days, transactions such as the lending of cash
were considered a form of charitable or social service However, under the BBA scheme, a seller-buyer relationship
whereby the lender was barred from making any profit from is established and the selling price is fixed upfront. The
his “generosity”. The borrower would have to pay the exact sale price is then repaid in installments, with the amount
amount borrowed — no more, no less. remaining fixed throughout the financing period. This
eliminates the customer’s interest rate risk and furthermore,
However, in modern Islamic finance, such practice is no arrears will not be capitalized. In short, the BBA scheme
longer suitable because as business entities, Islamic banks eliminates additional or hidden costs that will change the
need to make a profit to stay in business — subsequently price of the property purchased — providing clients with
adding cost to the transaction. Instead of charging interest a better value-for-money option compared to conventional
from loans, these banks offer financing facilities in other home financing.
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forms such as lease, sale and partnership. This allows them


to profit in ways that are permissible by Shariah law. ‘Compare apples with apples’
Baljeet Kaur Grewal of KFH Research said the answer
“There are various products in the market and it would not be to whether Islamic products are cheaper than their
accurate to simply assume that all Islamic finance products conventional counterparts depends on various factors, such

34 Islamic Finance Asia . August/September 2008


as the comprehensiveness of the “For Muslims, they should go for Islamic products because
existing regulatory framework. it is a religious requirement. Riba is a serious offence in
Baljeet said in Malaysia, which Islam and the punishment in the hereafter is harsh. However,
already has a solid framework this should not be a deterrent factor for non-Muslims as
Picture source: i-VCAP Management

and regulation in place and the principles in Islamic finance are not just about religion.
enjoys strong support from the They are about transparency, ethics and fairness, as well as
government, there have been promoting entrepreneurship and sharing of risks between
many instances when Islamic financiers and customers.
products proved to be more
competitive in pricing. “You do not have to be a Muslim to appreciate the beauty
of Islamic finance. The principles of Islamic finance are
Baljeet Kaur Grewal Specific legal provisions such more or less similar to the values emphasized in ethical and
as tax exemption, in addition green investment, which steer clear of investment activities
to having a complete value chain of Islamic products in associated with vice, weapons and activities that may be
the market, are among the contributing factors that would harmful to the environment.
enable Islamic finance to offer products at competitive
rates. In order to do this, players have to be more proactive in creating
market awareness,” she added. To create clear distinction
“This is not possible for countries that do not have a between Islamic and conventional products, many market
comprehensive framework and the necessary legal provision. experts stressed the need to come up with more genuine
For instance, issuance of Sukuk can be more expensive Islamic products instead of just coming up with adaptations of
than that of conventional bonds in countries that have not products offered by conventional banks.
addressed the double taxation issue. It boils down to the
regulatory framework and “If you want to compete, it is crucial to come up with a
incentives,” said the group different product — not a copy version. Sukuk is an example
chief economist and head of of a truly genuine Islamic product that has succeeded in
global research. garnering interest not only among Muslims but non-Muslim
investors as well. We need more of such products in order to
Meanwhile, Bank Islam expand the Islamic the finance share in the global financial
corporate investment banking market,” said an observer.
Picture source: i-VCAP Management

director Mashitah Osman


feels that price comparison Foster better understanding
would not be the right method Aside from creating awareness, Mashitah said there is a
to use. She pointed out Islamic crucial need for the Muslim community to play a part in
finance should be viewed improving understanding of Islamic financial products.
as a category on its own —
and not as an alternative to Sharing her experience in dealing with potential customers
Mashitah Osman
conventional finance — as it in non-Muslim jurisdictions, she said she had come across
provides the market with another financing option. situations where these customers were apprehensive of
investing simply because of the name “Islam” even though
“In order to be more accurate in your evaluation, it is they liked the products offered.
important that you compare apples with apples. This is
not the case when comparing Islamic and conventional In fact, some even requested that the word “Islam” be
products as both operate on two different business models,” replaced with “Shariah”, fearing that it would trigger
she pointed out. uneasiness among their regulators as well as clients, some
of whom hold the view that Islamic finance activities could
Mashitah added that to be able to truly appreciate Islamic have been extended to support acts of terrorism.
finance, one needs to look at the model in a holistic manner,
not just at the costs involved, and try to understand the “This is among the key public relations challenges that need
reasoning behind the restrictions imposed. to be addressed, especially by key market players,” said
Mashitah. One way to do this, she suggested, is for the
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She explained the five principles of Islamic finance — which Muslim community to work on a global public relations
prohibit interest (riba), uncertainty (gharar) and activities program. She fears that the overwhelming debate and over-
related to vice, alcohol and pork as well as the emphasis on concentration of issues relating to differences in interpreting
profit and loss-sharing and asset backing principles — are Shariah law concerning Islamic finance could slow down
mainly to promote good business practices. the growth momentum of the sector.

August/September 2008 . Islamic Finance Asia 35

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