Differences Between Syariah and Conventional Financing

Consumers of financial products in Malaysia now have more loan options, thanks to syariah financing.

Syariah financing, like conventional financing, is available for anyone in need of additional funds for consumption goods or capital.

And almost all large banks now offer syariah financing, so consumers don’t have to worry about the level of professionalism in the management of funds.

Still, there are several differences between syariah and conventional finance which you should consider before choosing between the two.

1. Interest vs No Interest

In conventional financing, the bank charges interest on the loan, and customers are required to repay the loan along with the interest.

However, Islamic banking considers interest as riba, and hence, doesn’t allow it. Syariah financing applies akad murabahah (buy-sell), ijarah wa iqtina (leasing with the option of ownership), and musharakah mutanaqishah (capital sharing) instead of interest.

In murabahah, the bank “buys” the item the customer intends the loan for. Then, the bank sells the item to the customer with a certain margin. For example: A customer wants a loan for a new car. The bank will buy this car and sell it back to the customer for a minimal profit. The total amount including the margin will be paid in installments over a period of time customers. The margin is the bank’s profit.

In ijarah wa iqtina, the bank will buy the desired object and the customer will lease or rent the object for a certain period of time. However, after using the object for that period, the customer can choose to fully buy the object.

In mutanaqishah, the bank and customer share the capital costs and hence, ownership. For example, the bank finances 60% of the car purchase, and customer finances the other 40%. Later, the customer can the bank’s share to fully own the car.

2. Risk Sharing

In conventional financing, the customer bears all the risk of paying back the loan. However, in syariah financing, the banks bear some risk because of the loan principles involved.

For example, if a customer borrows capital to start a business, the customer still has to pay back the loan principal and interest even though the investment turns out to be a loss and only brings back a smaller return than the original capital.

However, if a customer borrows the same principal as capital from syariah financing based on mutanaqishah, the bank will bear some of the losses if the investment is a loss and the customer only gets a smaller amount back.

3. Halal

Syariah financing is meant to support halal purposes. So, consumers must inform banks on the intended use of the loan, and once they receive the loan, must use it as promised.

Because of the differences that exist, you are advised to talk to banks about their syariah and conventional financing structures. Careful calculation will help you get the best product that meets your financial needs.

Compare personal loans in Malaysia and see which local banks make syariah financing available.