A Comparative Study of Profit and Interest Rate Practice in Malaysian Banking

A Comparative Study of Profit and Interest Rate Practice in Malaysian Banking

Muhamad Zuhaili Saiman*

Academy of Contemporary Islamic Studies (ACIS), Centre of Foundation Studies, University Technology MARA (UiTM), Dengkil Branch, MALAYSIA

^*Corresponding author

DOI: https://dx.doi.org/10.47772/IJRISS.2025.906000367

Received: 10 June 2025; Accepted: 13 June 2025; Published: 17 July 2025

ABSTRACT

Basically, a bank is an institution that conducts financial transactions by accepting and collecting funds from depositors and carrying out financing activities with the accumulated funds to generate profit. In carrying out its functions as a financial institution, the bank will carry out all financial related transactions as permitted. Financial related transactions carried out by banking institutions will usually result in interest payments or profits to the customer due to savings or investments made and for financing transactions it will result in interest payments or profits to the bank. The problem that arises is the perception that there is no difference between the operation of Islamic banking and conventional banking, thus making the rate of profit in long-term financial instruments in Islamic banking the same as the increase based on the interest rate carried out in conventional banking. The objective of this study is to examine the operational differences between Islamic and conventional banking in long-term financial instruments for the determination of profit rates practiced. The research methodology used is a qualitative design based on literature review by analysing documents thru a deductive method analysis on primary, secondary, and tertiary sources to identify conceptual, legal, and operational differences between Islamic and conventional banking. The results of the study show that there are fundamental differences between Islamic banking and conventional banking, including long-term financial instruments. This difference is proof that operations in Islamic banking are bound by Shariah law and at the same time prove that the long-term profit rate obtained is Shariah compliant, not the same as the interest rate practiced in conventional banking.

Keywords: long-term finance, banking, profit, interest rate, financing

INTRODUCTION

The banking system in Malaysia practices a dual system where there are conventional banking institutions and Islamic banking that carry out banking operations simultaneously. Basically, both banking institutions carry out the same operations but what distinguishes them is their policies and implementation. For Islamic banking, it is certain that all its guidelines are in accordance with matters that are only permitted by Islamic law. This is because when based on Islam, its journey must be in line with the guidance of the Qur’an and Sunnah. In this regard, Islamic banking institutions must offer different things from conventional banking institutions which clearly contain elements that are prohibited by Islam. In general, whether conventional banking institutions or Islamic banking operate and are subject to acts and legislation under and regulated by Bank Negara Malaysia (BNM).

Despite the growing presence of Islamic banking in Malaysia’s dual financial system, there remains a persistent misconception among the public that Islamic banking operations, particularly in long-term financing, are merely a replication of conventional banking practices under different terminologies. This confusion stems primarily from the perceived similarity in profit rates and repayment structures, leading to doubts about the authenticity of Shariah compliance in Islamic financial products. While previous literature has examined the basic differences between Islamic and conventional banking, there is limited scholarly focus on the actual operational frameworks and the jurisprudential justifications that differentiate the determination of profit rates in long-term financial instruments. This gap in the literature necessitates a deeper exploration of how Islamic banks structure profit mechanisms in ways that are consistent with Shariah, especially in comparison to the interest-based model of conventional banking.

According to Cargill (1983), the role of the banking system in relation to the financial system is based on three things, namely :

1. Providing funds such as through deposits and creating opportunities to generate surpluses through various activities. The surplus obtained will be distributed to the less fortunate units and returns to depositors. Basically, banking is also a trading center that carries out business activities.
2. Able to demonstrate the ability to attract customer trust both in good economic times and otherwise to continue operating with sufficient funds.
3. The banking system is a system that is able to adapt to all changing economic needs due to the development and rapid growth of a country’s economy.

The three above are the basis of a bank. This is because all banks are basically places for savings, trade and have credit for deferred purchases. All depend on the product offerings by the bank. For conventional banking, there is no problem with interest rates being charged, but not in Islamic banking because any element related to usury is prohibited. This is where the difference in the principles and policies that affect the operations and activities of a bank is made. Next, the researcher presents a detailed explanation of conventional banking and Islamic banking to compare the two to answer the problems focused on in this chapter regarding the reduction of the value of deferred sales through the determination of rebates and interest rates. This is to distinguish the reduction in value that occurs between the two is not the same and to ensure that the application of rebates only applies to contracts that are recognized by Islamic law.

From the context, the objective of this study is to examine the fundamental legal, conceptual, and operational differences between Islamic and conventional banking with particular attention to the determination of profit rates in long-term financial instruments. The study also seeks to correct misconceptions by highlighting the distinct contractual bases and Shariah principles governing Islamic financial transactions. The significance of this study lies in its contribution to clarifying the theoretical and practical independence of Islamic banking operations, reinforcing public confidence in Shariah-compliant finance. This paper focuses on the Malaysian context, analysing literature and official documents, and does not include empirical data such as interviews or surveys. The scope is therefore limited to a doctrinal and comparative analysis based on textual and regulatory sources, while the limitation lies in its non-empirical, interpretative nature.

METHODOLOGY

This study uses a qualitative design based on literature review and content analysis methods based on the research problems that have been explained. The content analysis method is carried out to obtain information related to the concepts, legal foundations and operations of the Islamic and conventional banking systems. In addition, this article also uses a comparative method carried out on Islamic and conventional banking to analyze the differences in the scope of the study focused on, which involves long-term financial instruments. At the end of the study, this article will show clear findings of the differences between the two operations and Islamic and conventional banking systems in long-term financial instruments to determine the profit rate.

Data collection was done through document analysis techniques. This technique was chosen because it is a systematic approach to analysing data and information suitable for qualitative research. Document analysis was also found to be suitable for all types of data collected in this study, namely text data. Data collection through document analysis is also the best choice for collecting and analysing data for environments that are difficult to reach. This method is done by collecting all three sources of data, namely primary data, secondary data, and tertiary data. To ensure credibility and relevance, sources were selected based on scholarly authority, alignment with the research scope, and institutional reliability specifically including peer-reviewed journal articles, regulatory documents issued by Bank Negara Malaysia, classical Islamic jurisprudential texts from recognised madhhab scholars, and books published by academic presses. Primary data is used as a basis for answering the research questions, while secondary data is a catalyst for the policy being discussed and tertiary data is used as a data review from existing information. The researcher also collected data produced from past studies or written results based on references, whether primary or secondary.

Next, the researcher conducted a data analysis method using the deductive method. This method will generally understand the study involving long-term finance practiced in both Islamic and conventional banking to strengthen the understanding base according to the consideration of the sharia perspective. Then the study will be carried out in detail on the calculation in determining the profit rate in long-term financial instruments between Islamic and conventional banking. The approach used by the researcher is to make a comparison between the two banks to study the views of Islamic scholars as a site for strengthening understanding of fiqh law, followed by a specific discussion on contemporary issues that focus on the problem, namely long-term financial instruments for determining the profit rate. For that, this study will analyze data from research content and documents related to operations and practice systems in Islamic and conventional banking to see the differences between the two starting from the law to the calculation method in determining the profit rate obtained through long-term financial instruments.

RESULTS AND DISCUSSIONS

Conventional Banking Systems and Operations in Malaysia

The conventional banking system is a banking system that provides banking services and is based on modern banking practices that are based on calculating interest rates in the implementation of banking transactions. The interest rate charged on loans is higher than the interest rate on savings. This is because the bank is to mobilize all its activities to obtain profits (al-Salus, A. A, 1992 & al-Qal’ahji, M. R, 2005). It consists of instruments, institutions, markets and regulations related to trade flows that will accelerate the flow of funds from buyers to sellers and from savers to borrowers by providing payment services, mobilizing savings, strengthening credit, limiting and setting prices and collecting and trading risks.

According to Case & Fair (1994), interest is a payment given for the use of money or a payment imposed on borrowers by the party providing the loan as a result of the use of money or capital. Therefore, in terms of practice, interest exists as a result of the implementation of financial transactions involving loans, savings or investments based on a set percentage rate and it is known as the interest rate. The interest rate is a measure of the annual payment value for a loan as a percentage of the loan amount.

The existence of interest rates in the conventional banking system is a necessity due to several factors, including (Hamzad, 1991) :

1. Investments requiring capital.
2. Offering capital for profit sharing.
3. Purpose of business activities, also for speculation and speculative Behaviour.

In practice, the determination of interest rates varies according to the circumstances and time whether the interest rate involves loans, savings or investments because its nature is the same as the price determined by supply and demand in a market. Among the reasons that make interest rates different in loan transactions are (Siti Rohana, 1989) :

1. Risk level.
2. Loan term.
3. Administrative costs.

Apart from that, interest rates also affect savings or investments and when someone opens a savings account or makes an investment in a banking institution, they will earn interest on their savings for a certain period of time. The interest rates charged to customers vary from bank to bank. It can happen by setting it directly from the institution and can also be based on negotiations between the bank and the customer. The provision of this interest rate in terms of percentage also depends on market trends and the economic situation at a certain time (Rosli, 1994).

Thus, interest is the core of the practice of the conventional banking system which has a specific calculation method to enable the bank to obtain additional payments from the banking products offered. This calculation refers to the original amount of principal, the period or term and the interest rate set for the transaction. This calculation involves the majority of conventional banking transactions whether related to deposits, loans, financing or services. The methods used in calculating interest as per conventional banking practice are simple interest, compound interest and annual balance annuity. It can be understood briefly as follows :

Basic interest: the amount of interest paid solely based on the principal amount of money given or lent and it is usually charged on transactions carried out for a short period. The calculation based on this interest is done simply and easily as follows (Adem, 2006) :

            I= p x r x n, where;

I is the amount of interest

p is the principal amount

r is the interest rate

n is the period of execution of the transaction

(r and n must be consistent, i.e. if r is stated in annual terms then n must also follow the annual term)For example, if someone borrows money from a bank for RM 10,000 for a period of 3 years with an interest rate of 10 percent per annum, then the total interest that must be paid is :

I= p x r x n

            = (10 000)(0.10)(3)

            = RM 3000

Based on the calculation example above, the total interest payable is RM 3,000 with an original loan amount of RM 10,000 which charges interest at a rate of 10 percent per annum for 3 years (10% x 3 years = 30%).

Compound interest (Jean, 2004) :  a calculation method commonly used by banks or financial institutions in their daily transactions involving customer deposits or savings. Calculations based on this method allow the amount of interest generated to be reinvested as part of the principal amount in the following year as shown in the following calculation:

S = p (I + r)ⁿ

S is the compound interest

p is the principal amount

I is the interest

r is the interest rate

n is the term of the transaction

Based on the calculation method above if the interest uses the compound interest method, it will be as follows :

S = p (I + r)ⁿ

p = 10 000 + (I + 0.10)³

   = 13 270

I  = s – p

  = 13 270 – 10 000

  = 3270

So based on the compound interest calculation method for a period of 3 years, it will produce a total of RM 3270 because compound interest makes the interest in the first year part of the principal amount for the second year and onwards.

Annual Balance Annuity (Ab Munim, 1993) : involves the repayment of a loan periodically because part of the payment is for the principal loan and the rest is the interest charged for the loan. The interest charged for this loan is calculated based on the principal loan amount and multiplied by the percentage according to the interest rate set by the bank.

Calculating interest based on this method allows the borrower to repay the principal loan amount as well as the interest rate charged each time they make a payment. This means that the amount of interest that must be paid at the set rate will decrease as a result of the repayment of the loan because the interest rate is calculated based on the remaining principal loan amount and not the total loan amount as in the simple interest calculation. The table below is an example of the calculation based on the loan amount taken of RM 104,000 while the set interest rate is 9 percent per year for a period of 15 years.

Table 1 Loan principal and interest repayment schedule

Source: Adapted from Islam Kamal (2021)

Based on the calculation above, the total monthly periodic payments that need to be paid out of the total amount that needs to be paid are as follows :

            Monthly Installment  =           Monthly Annual/ 12

                                               =           RM 12 896/  12

                                               =           RM 1074.66

Table 2            List of commercial banks (conventional system) operating in Malaysia

Source : SME Corp Malaysia (2022)

Islamic Banking System and Operations in Malaysia

The Islamic banking system refers to banking practices that are carried out in an Islamic manner based on the guidance of the Qur’an and Sunnah. Every activity and matter carried out will be ensured to be matters that do not conflict with the Sharia. This means that every offer by Islamic banking and all savings and loan operations must also be in accordance with Sharia compliance. The implementation of this principle also includes other bank transactions such as remittance services, letters of guarantee, letters of credit and foreign exchange. Apart from that, the main objective of establishing Islamic banking is to ensure that Muslims have a choice in banking that complies with the Sharia for an activity carried out in meeting current needs. The basis for business operations carried out is according to the Qur’an and Hadith, which is based on the concept of justice and meeting the demand for equality in the life of the ummah (Surtahman, 2006).

Referring to the principles and practices of Islamic banking based on sharia, what needs to be understood about the principles that are the core of these practices and implementations is :

1. Compliance and preservation of the objectives of the Sharia (maqasid al-shariah) which generally aim to provide benefits to humans by ensuring that they are achieved and avoiding all forms of harm.
2. Implementation of financial transactions that do not involve any usury practices, elements that are related to usury practices or that can lead to the existence of usury.
3. Implementation of the contract must coincide with the law of contract in Islam which is protected from any elements prohibited by the Sharia.
4. The object in the contract must meet the conditions that have been set to enable it to be accepted as an object according to the law of contract in Islam.
5. Protected from the elements of uncertainty (gharar) which refers to goods and gross disparity in price (ghabn fahisy) which refers to prices. Uncertainty (gharar) is intended to obscure the views of the customer so that he thinks that the transaction produces benefits and goodness. While ross disparity in price is the price displayed is too high compared to the actual price for the purpose of fraud to obtain excessive profits.

With the Islamic Banking Act in 1983, the separation of the Islamic banking system in Malaysia was made to allow Islamic banking to operate alongside conventional banking. In addition, the Government Investment Act 1983 (GIA) which was enacted in the same year allowed the government to issue government investment shares (Gorverment Investment Issues – GII) based on Islamic principles. The existence of GII will enable Islamic banks to obtain the liquidity they need with the function of this GII as an instrument that aims to absorb and which is not used in the short term.

The first bank established for sharia-compliant operations was Bank Islam Malaysia Berhad (BIMB) which was established in July 1983. It is subject to the Islamic Banking Act and is fully regulated by Bank Negara Malaysia. The plan for its establishment was to develop an Islamic banking system that is not tied to the conventional system that is able to compete with existing conventional finance. It is also an alternative for Muslim consumers, especially to be able to avoid any activities that conflict with Islamic law in the context of economics, finance and banking. In fact, in the competition of Islamic banks with conventional ones, it moves more in stages through the acts and schemes that are established. This is because of the attachment to several acts that need to be enacted first which involve legislation. These efforts were strengthened to expand the Islamic banking business in obtaining more and more depositors. Then the implementation of the Interest-Free Banking Scheme (SPTF) in March 1993 which was applied to savings in Islamic banking to differentiate conventional banking which is based on interest rates.

Another important development in Islamic banking is the establishment of the Islamic money market on 3 January 1994. It provides an advantage to the Islamic banking system by facilitating short-term portfolio coordination and acts as a channel for the implementation of financial policies for Islamic banking institutions. This market consists of three aspects, namely Islamic financial instrument transactions, interbank mudarabah investments (PMAB) and the Islamic cheque clearing system. Subsequently, the Malaysian Islamic banking system continued to grow with the establishment of the second Islamic bank, Bank Muamalat Malaysia Berhad (BMMB) on 1 October 1999. It was launched after the Sharia Banking System by Bank Kerjasama Rakyat Malaysia (Bank Rakyat) in May 1993.

After ten years of Islamic banking, it began to be seen as positive and its impact made conventional commercial banks start offering Islamic banking services starting with the introduction of the Interest-Free Banking Scheme (SPTF) in 1993 through the Islamic Banking Unit (IBU) before being amended to the Islamic Banking Scheme (SPI) in 1998 and raising the status of IBU to the Islamic Banking Division (IBD) in 1999. And in 2004, Bank Negara Malaysia invited commercial banks including foreign banks to establish their own Islamic banks as a subsidiary.

The financial instruments provided by Islamic banking are based on certain transactions for a banking institution. In practice, they can be divided into five major areas, namely (Abd Ghafar & Surtahman. 1993, Sudin. 1996 & Ab Munim. 1999):

1. Savings: allows people to save money and withdraw part or all of it when needed. This occurs through two types of accounts, namely savings accounts and current accounts, and both of these contracts use the principle of al-wakalah in their implementation.
2. Investment: obtaining funds or capital from individual or organizational investors. This investment is made within a certain period of time and when it reaches maturity, the investor (customer) is entitled to receive the profit from the investment. This transaction is carried out based on the principle of al-mudarabah, either in the form of a general or special investment account.
3. Financing: the bank provides financing to customers who need it, whether it is financing for the short, medium or long term. It helps the bank to make a profit and balance the liquidity in cash flow. This financing offer, whether short or long term, provides benefits to customers to avoid getting involved with conventional loans.
4. Loan: helps customers obtain cash either for consumption or productivity purposes. Loan transactions carried out without any interest or interest being charged to the customer. This transaction can be carried out based on two principles, namely qard hasan (welfare loan) or al-rahn (mortgage).
5. Services: involves work or efforts carried out by the bank to enable it to receive payment from the customer for the services provided. This service is carried out based on the principle of al-ujrah (wages) meaning that the bank is the party that receives payment for the services provided. In addition, the bank also applies the principle of al-bay’ (buying and selling) in transactions involving foreign exchange services where the bank will act as a buyer of foreign currency in one situation and as a seller in another situation.

Table 3 List of Islamic banks operating in Malaysia

Source: SME Corp Malaysia (2022)

Long-Term Profits of Islamic Banking Based on the Time Value of Money

Deferred sales are currently being carried out very widely due to current needs. Deferred sales or long-term financing involve the question of the time value of money. The time value of money refers to the fact that a value influences the increase or decrease in value. Although the period is not the contracted item, it influences the price factor, whether in cash or deferred terms in particular. This is because the value is different for different times. Especially those involving long periods such as 20 years. (Muhamad Zuhaili & Ahmad Dahlan, 2017)

In Islamic finance, the time value of money is not something new and isolated. In fact, previous Islamic scholars have discussed it a lot by relating it to the sale and purchase contract. This is because the time value does not apply to the qard contract, but it can be accepted in the sale and purchase contract that is based on the principle of justice. Among the classic contracts related to the time value of money is the al-murabahah contract which discusses the production of profit through deferred time. The time value in the sale and purchase contract can be given an increase and is eligible, but it must be ensured that the full value of the sale is clearly communicated (al-Kasani, 1986). If the increase is on the deferred period, it will cause usury and similarly if the increase is on the sale and purchase contract but the full value of the sale, it will not cause the existence of uncertainty (gharar).

Previous Islamic scholars acknowledged and permitted the increase through the time value of money in transactions carried out as long as the pillars and conditions related to the contract are maintained in principle. However, the discussion was more general and did not detail the calculation through the time value of money until it was seen as the same calculation as the application of interest rates in Islamic banking. This resulted in the perception that would arise when relating the issue of price increases and expensiveness and making Islamic finance no different from finance based on usury. This is more evident when there are Islamic financial institutions that pursue maximum profit and ultimately profit is the goal even though they use the argument of the time value of money. As a result, the community of customers in Islamic banking felt that there was no difference between them being involved with conventional banking because the price value offered by both banks was seen as the same.

Although the issue related to the time value of money has been discussed fundamentally through several contracts that have been created, including the bay’ al-murabahah contract, baycatan fi baycah, dac wa tacajjal and al-qard hal am mucajjal, it is still an issue that needs to be discussed today to further detail the time value of money so that the calculation related to deferred profits in Islamic finance has its own calculation that is seen separately from conventional finance from the perspective of name, operation and calculation of determination (al-Kasani. 1986, al-Dasuqi. 1996, Ibn Abidin 2005 & Ibn Qayyim. 2010). This is because the debate of previous Islamic scholars simply explained that Islamic finance acknowledges the existence of economic value for the time factor in every financial transaction.

The debate that has taken place only revolves around the definition, justification or factors that influence a rule in a transaction contract. The technicalities of the calculation of determination have not yet been discussed in detail. Because of this, in the application of the time value of money there are also several criticisms that arise due to the similarity of value with interest rates. In fact, the mere reason for the benefit of a price increase is not strong, but must have its own calculation which shows that Islamic finance does not depend on the calculation in conventional finance (Muhamad Zuhaili & Ahmad Dahlan, 2015).

In the description of the time value of money, many explanations are clear regarding the al-murabahah contract. The explanation made is that the time value of money in the al-murabahah contract is created because the deferral period in the first purchase must be informed to the second buyer because the second buyer is also buying on a deferral basis. Without notification, it is considered a betrayal because time has value and that value must be informed by the contracting party. The same is true in the installment sale contract. Islamic scholars allow that the cash price and installments are different. This is because installments are also deferred in nature, but they are more specific compared to deferred sales in general. Such explanations can be referred to, among others, in the writings of the Hanafi school of thought such as al-Kasani (1986), al-Sarakhsi (2001) and Ibn Abidin (2005).

Ibn Abidin (2005) in a discussion on price increases in al-murabahah contracts as follows:

أَلَا تَرَى أَنَّهُ يُزَادُ فِي الثَّمَنِ لِأَجْلِهِ

 Meaning: “Don’t you see that the price has been increased because of it (the delay)?”.

Not only scholars from the Hanafi school of thought but also scholars from other schools of thought have discussed the time value of money such as al-Dasuqi (1996) from the Maliki school of thought, Ibn Taymiyyah (2005) from the Hanbali school of thought and al-Sharbini (2003) from the Shafi’i school of thought. al-Dasuqi (1996) states as follows:

وَجَبَ عَلَى بَائِعِ الْمُرَابَحَة بَيَانُ ) الأَجَل ( الَّذِي اشْتَرَى إِلَيْهِ لِأَنَّ لَهُ حِصَّةٌ مِنَ الثَّمَنِ

Meaning: It is obligatory on the seller under al-murabahah to inform about the grace period for his purchase (before selling to the buyer) because the grace period has its share in the price.

Al-Sharbini (2003) explains the value of time in al-murabahah contracts as follows:

 وَكَلَامُهُ يَقْتَضِي اشْتِرَاطُ تَعْيِينِ قَدْرِ الْأَجَلِ مُطْلَقًا وَهُوَ كَذَلِكَ ؛ لِأَنَّ الْأَجَلَ يُقَابِلُهُ قِسْطٌ مِّنَ الثَّمَنِ

Meaning: The statement provides the requirements for the purpose of determining the absolute deferral rate because the deferral is given in return for a price.

Although the initial debate that the deferred period has doubts about it when it is valued like the contracted goods, the fact is that it is liked by them, especially the sellers in the transactions carried out, but its existence cannot be managed separately from the contracted goods. What is said to be doubtful is the additional value imposed due to the period indicating as if in the al-murabahah contract the first buyer buys the goods and the period after the goods are sold is added to it the value of the first purchase and the deferred period. Therefore, without the notification of the first purchase it can create betrayal because the dimension of the deferred time causes the value of the sale to increase. Indirectly, such a debate shows the recognition of the value of a period of time.

Similarly, the debate on the time value of money can be referred to the debate on baycatan fi baycah (two sale and purchase contracts in one sale and purchase contract). The basis of baycatan fi baycah is prohibited like one item with two selling prices. Like someone saying: “I am selling this item for RM 20 in cash and RM 40 in deferred”. Then there is no price that is determined and agreed upon. The buyer only takes the goods while the price is not determined. So this is prohibited because there are two buying and selling transactions in one transaction. On the other hand, if both parties agree on one price, either in cash or deferred, then it is valid and not included in the prohibition.

Clearly based on the description, the interpretation that can be made is that the cash sales price is lower than the deferred sales. What is prohibited is not the deferred price being higher than the cash sales price but when there are two prices at the same time without being decided. Indirectly. the debate on the baycatan fi baycah also recognizes the time value of money which shows that the deferred period has its own value which increases the cash value (al-Masri, 2001). Thus, every argument that shows the necessity of deferred sales shows the recognition of Islamic scholars on the time value of money.

For contemporary Islamic scholars, they are found to discuss issues related to the time value of money in distinguishing it from finance based on usury or interest rates. They are more focused on building new contracts to avoid usury in a contract that is carried out. This is because the issue of accepting the time value of money has been resolved at the level of debate by previous Islamic scholars with examples of contracts discussed previously. What contemporary Islamic scholars do is to resolve a contract involving deferred sales or long-term financing that is free from the forbidden element of usury. (Muhamad Zuhaili & Ahmad Dahlan, 2017)

Therefore, there is a difference of opinion among Islamic scholars regarding contracts such as bayc mucajjal, bayc taqsit, istisnasac and cinah. This is because the cause of this difference of opinion is in their acceptance of the theory of Positive Time Preference. This theory is also acknowledged by Western scholars and makes the determination of interest rates based on usury also justified based on the time value of money. It seems that there is a similarity with the time value of money discussed by Islamic scholars. Among the Western scholars who introduced the time value of money as a justification for usury on loans is the Austrian economist Eugene Von Bhom-Bawerk. He introduced it at the end of the 19th century through his writing entitled Positive Theory of Capital. He presented a theory called positive time preference as a justification for legalizing usury on loans. (Muhammad Akram, 2008)

The basis for building this theory is the fact that people generally prioritize using their money now over saving it for future use. Therefore, someone who pays a sum of money now should receive a larger repayment of that money because the present value of goods in the future is low. The result is that the value of goods in the future needs to be increased sufficiently to create a difference between the present value and the future value. He termed this difference as the natural rate of interest (Muhammad Akram, 2001). The parallelism of this theory with Islam caused early Islamic scholars to state that something that is cayn is better than something that is dayn (debt) while immediate is better than termed (al-Zayla’i, 2010):

لِأَنَّ الْعَيْنَ خَيْرٌ مِنَ الدَّيْنِ، وَالْمُعَجَّلُ أَكْثَرُ قِيْمَة مِنَ الْمُؤَجَّلِ

Meaning: Because cash is better than debt and something that is expedited is more valuable than something that is delayed.

The increase in deferral is a compensation because the financier or seller has sacrificed the desire to get cash but does not have it in full because it satisfies the customer’s desire to get a product even in a state of lack of cash. Therefore, the increase is a compensation for the period implemented by the financier and is justice on his part. This is because the customer is able to have something in a state of inability to pay cash. This is justice for both parties who each benefit from the deferred sale. Moreover, the increase based on the period is a hedge against the risk of future economic uncertainty faced by the financier (Muhamad Zuhaili & Ahmad Dahlan, 2017).

On the surface, there is doubt when the increase in deferred sales is equated with the increase in qard contracts through interest rates. This is because each claims that the increase occurs due to the deferred period that exists. This makes contemporary Islamic scholars present a significant difference between the increase caused by the period in financing is permissible while the increase in qard (debt) contracts is prohibited by consensus. This is because the basis of the contract is different from each other. The sale and purchase contract which is muawadat (commutative contract) refers to the exchange of two parties, more emphasis on justice while the qard contract is voluntary (tabarru’). Therefore, the increase in financing transactions brings justice while the increase in qard contracts is contrary to the voluntary principle because it seems to take advantage of the less capable debtor (al-Tukri, 2003).

Long-Term Profits of Conventional Banking Based on Interest Rates

Basically, conventional banking practices interest rates in transactions offered either in the form of savings or investments. In fact, this interest rate is used in loan transactions whether term or non-term. Uniquely, this interest rate is a benchmark for the profit rate over a period of time. Therefore, in conventional loans or financing, there is no fixed profit rate applied, but rather a variable or floating profit rate that will always change with the effect of the increase in BR by conventional banks based on the OPR supervised under BNM.

Variable profit rates in terms of implementation are more practical to deal with uncertain economic situations and do not favor only one party, whether the recipient of financing or the depositor. Banks have reasonable reasons to charge higher prices or vice versa to customers in their product financing transactions and provide appropriate returns to depositors. This allows Islamic banking institutions to compete with conventional banking institutions which indeed practice variable interest rates in most financing transactions, especially those involving long-term financing. This practice enables conventional banking institutions to cope with the risk of rising costs of money by passing on the cost to customers who receive financing. Conversely, if the cost of money decreases, customers will also benefit from the decrease in the form of repayments of the financing (Muhamad Zuhaili, Ahmad Dahlan & Shoffian, 2019).

The fact is that financing products from conventional banking are actually based on debt that is charged interest rates through the available grace period. Therefore, it can be understood that the financing transactions offered by conventional banks with their variety of products are debts that require the debtor to repay the debt along with interest. For that, conventional banking institutions actually provide banking services based on modern banking practices which are based on the calculation of interest rates in all their banking transactions. It accepts savings and provides financing and loans with certain interests.

Conventional banks are institutions that carry out business related to financial transactions or precisely institutions that carry out transactions involving money. They are intermediaries between the recipient of financing (borrowers) and the lender (depositors) and the difference between the interest rate received for the use of money given as a loan compared to the interest rate that must be paid for the money is the profit for a banking institution. This means that the bank is actively involved in collecting and transferring small amounts of money that were previously unproductive to individuals or business organizations by providing additional capital requirements to run a business. Thus, the bank plays a role in distributing capital funds using its full power and at the same time it strives to increase the amount of capital savings to increase its power. In simple terms, we can understand that the bank actually makes short-term loans by receiving money from depositors and then providing long-term loans to its old customers. This shows that most of the transactions carried out are actually loans of money (debt) in the name of financing (Ab Rahim, 2012).

Financing in conventional banking is the business of providing credit, either directly by providing loans or indirectly by investing through the capital market. In the financial market, banking institutions bring together market participants who experience a capital deficit (borrowers) with market participants who have a capital surplus (investors and depositors) by transferring funds from parties who have excess funds (financial assets) to invest to parties who borrow funds to make investments in real assets. Conventional banks lend money by providing advance facilities to current account customers or by providing loans in installments and most of these funds are lent to households and non-financial business organizations.

Therefore, in practice, conventional banking financing is a loan, which is the provision of credit to consumers or business organizations in the form of funds given as a debt that must be repaid along with interest (interest). This financing involves secured loans, which are a form of loan that requires the borrower to pledge a certain asset, for example a car or property as collateral, or unsecured loans, which are financial loans that are given without requiring any form of collateral from the borrower’s assets. Both types of financing are available from conventional banking institutions that offer their various financial products such as (Zaharuddin, 2010) :

1. vehicle loan.
2. personal housing loan.
3. capital loan.
4. machinery or equipment purchase loan.
5. personal loan.
6. bank overdraft.
7. credit facility.

Financing provided by conventional banking institutions in the form of loans with various different loan packages to accommodate various consumer needs will be charged an interest rate. This interest rate is a compensation that is assessed as the price to be paid for the use of borrowed money. Usually, a large part of this money is from depositor funds. In this regard, compensation must be paid to the lender for the risk of losing money known as credit risk as well as for giving up other investments that may have been made using the assets provided as loans and this interest is considered the price of credit. This interest rate is determined in accordance with the base lending rate supervised at the BNM level. It can be charged either as a fixed rate or as a variable rate.

Fixed loan rates are based on a fixed interest rate and allow customers to be aware of the amount of installments that need to be paid. This is different from loans with variable interest rates that follow changes in the loan base rate (BR). If the rate increases, then the interest rate charged will increase and so will the customer’s monthly installment payment. However, if the loan base rate decreases, then the customer will enjoy the benefits because the monthly payment will also decrease. Apart from that, there are also loans with variable interest rates but the installment payment is fixed. If there is a change in the interest rate, then what changes is the loan repayment period, whether it will decrease or increase in length (Muhamad Zuhaili, 2022).

CONCLUSION

The comparative analysis confirms that Islamic and conventional banking operate under distinct frameworks. While both collect deposits and engage in financial transactions, Islamic banking adheres to Shariah principles, ensuring that all contracts and transactions are compliant. This includes long-term financial instruments, where profit is derived from permissible increases in deferred sales, justified by the time value of money endorsed by the four major Islamic schools of thought.

In contrast, conventional banking systems allow interest-based gains without Shariah constraints, accepting usury and uncertainty (gharar) as part of profit-making. However, in Islam, profit must be Shariah recognized and free from prohibited elements like riba (usury).

This fundamental legal distinction separates the two systems. While calculation methods may appear similar, the contractual basis and Shariah framework differ significantly. Hence, the profit rate in Islamic banking cannot be equated with conventional interest-based rates. Moving forward, Islamic banks are encouraged to strengthen their independence, particularly in rate-setting mechanisms, to reflect true Shariah values in managing economic volatility.

ACKNOWLEDGEMENT

The authors would like to express our greatest gratitude to the Academy of Contemporary Islamic Studies (ACIS), Centre of Foundation Studies, University Technology MARA (UiTM), Dengkil Branch for their indefinite support, which enabled this article to be published in the journal.

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