The nature of the contractual relationship between a customer and the financial institution is another prominent difference between Islamic financial institutions and conventional financial institutions. The contractual relationship between a customer and a conventional financial institution is usually based on an interest bearing loan where the customer is the borrower and the institution is the lender or vice versa. On the other hand, the contractual relationship between the customer and an Islamic financial institution takes on a variety of forms based on the type of product or service offered and the underlying contract on which it is based. Under each contractual relationship, there are different conditions and responsibilities which must be met by both the parties. 

For example, if a customer would like to get a new car, if they approach a conventional financial institution, they will borrow the amount required to purchase the car and be required to pay the amount back with interest over a period of time.  A customer approaching an Islamic financial institution, will enter into a type of sale agreement, whereby the customer would purchase the car from the institution once it was under the institution’s ownership & possession. Hence the contractual relationship between the customer and Islamic financial institution in this scenario is that of Purchaser (Customer) & Seller (IFI).  

Another example is when a customer needs to purchase a house. If the customer goes through a conventional financial institution, it would get a loan and pay the amount back with interest as was the case in the car example mentioned previously. On the other hand, a customer of an Islamic financial institution, would enter into a lease agreement or sale agreement with the IFI, depending on the type of product offered. Hence the contractual relationship between the two is that of Lessor or Seller (IFI) and Lessee or Buyer (Customer).

Customers opening an account with a conventional financial institution would in essence be lending his money to the conventional financial institution and receive interest from the institution in return. Therefore, the contractual relationship between the two would be that of Lender (Customer) and Borrower (Institution). A customer opening an account with an Islamic financial institution and expecting some return, would be investing his money on a type of partnership (Mudaraba) basis, whereby the customer would be the silent partner and the Islamic financial institution would be the party putting in the technical investment work. They would share any profits earned between them based on a pre-agreed profit sharing ratio whereas any financial loss would be borne by the customer. The Islamic financial institution would lose the time and effort it put into investing the customer’s money. 

Therefore, we see that a major difference between Islamic and conventional financial institutions is in regards to the nature of the contractual relationship between the customer and the institution. Customers and conventional financial institutions typically have a relationship of Lender and Borrower based on interest. Customers and Islamic financial institutions have a variety of different contractual relationships depending on the product or service offered and the underlying contract on which it is based. Furthermore, each contract has its own conditions and responsibilities placed on each contracting party according to Shariah.

To read the previous post (#7) of this series, please click the link below:

 https://rizqonomics.com/blog/similarities-differences-between-islamic-conventional-financial-institutions-7/