Ahmad et al 2. Islamic banking and prohibition of Riba/interest. Afr. J. Bus. Manage.

The basic aim of Islamic banking is to perform interest-free activities based on principles of Sharia’h and carry out only Halaal (permissible) transactions. The most important feature of Islamic banking is the sharing of risk among the investors, the bank and the borrowers. Islamic banking focuses on fairness and freedom as a centrally controlled and individually managed system according to the instructions of Allah Almighty. Islam is a complete code of life that is built upon the instructions given by the Allah Almighty and practices of the holy prophet Muhammad (peace be upon him). The holy Quran is the written instructions of Allah Almighty for humans. It covers all aspects of human life and all types of activities (that is, religious, social and economic) that are per-formed for the success in this life and in the life hereafter. There are clear instructions about Haalal and Haraam. Islam is a universal faith that promotes brotherhood, social equality and fairness in economic activities for the welfare of the mankind (Chapra, 1985).
It was proved that equity participation has a great potential for larger profits along with benefits of decentralized decision-making (Wieltzman, 1984; 1985). Equity contract is superior to debt contract due to a number of benefits. It improves the profitability of business units by eliminating the limitations as imposed by debt. Furthermore, equity based banking contracts stimulate the investment in the economy (Haque and Mirakhor, 1986).
Riba, interest, or usury is strictly prohibited in Islam as dealing with Riba-based transactions means declaring war with Allah Almighty and His Messenger (Muhammad, peace be upon him) Sura-e-Al-Bakara (2:279). Islam is defined as total submission to Allah Almighty without any condition. It is a complete code of life that consists upon the instructions of Allah Almighty and the practices of the Holy Prophet Muhammad (Peace be upon him). Every-one in this world performs religious, social and economic activities in one's life. But most of the times social and economic activities are originated and linked with the religious activities. Islam provides a comprehensive set of instructions to face any challenge. Economic activities reflect the earning and spending pattern of people, which is closely associated with religion in the form of being permissible (Halaal) or forbidden (Haraam).
Interest by definition is an additional amount paid/ received on the principal amount according to an agreement due to a time period attached thereof. Even a single additional penny on the principal amount or any other benefit attached with this transaction is considered as Riba (Rehman, 1993).

Main difference	Islamic Bank	Conventional Bank
Principles	Islamic banks follow the Principles of Sharia’h given by Allah Almighty to perform operations and activities.	Conventional banks follow manmade principles to perform operations and activities.

Source of earnings	Profit, service charges and consultancy fee is the main source of earnings of Islamic banks. Profit is variable which may be negative in case of loss.	Interest is the main source of income for conventional banks that is charged on different types of loans/products. (Difference between interests charged from borrowers and paid to depositors). It assures a predetermined rate of interest.

Risk sharing	Risk is shared among borrower, lender and bank.	Risk is fully transferred to others.

Profit maximization	It aims at maximizing the profit but subject to principles of Sharia’h.	It aims at maximizing the profit without any restriction even at the cost of other stakeholders.

Objectives	Islamic bank works as a trading concern to generate its income.	It generates income as financial intermediary. Its prime goal is the maximization of shareholders’ value at any cost.

Nature of earnings	Income of Islamic banks varies depending upon business borrowers and environment. It may be negative in case of loss.	Income of conventional bank is constant even if business borrowers suffer from loss because it charges fixed rate of interest irrespective of profit volume.

Islamic and conventional banking could be differentiated on the basis of objectives, risk sharing and interest based transaction (Ahmad et al., 2010). The main differences between Islamic and conventional bank are summarized in Table 1. Uzair (1976) has presented the working structure of Islamic bank and developed a mechanism to cope with the challenges of risk and interest. Risk of loss is a potential threat that creates obstacles for productive activities in the economy. The study suggested that Islamic banks could help to reduce risk to enhance productive activities in the economy. It is reported that different stakeholders dealing with Islamic bank are risk neutral and actively engaged in productive activities according to profit and loss based contracts (Siddiqui, 1973). Friedman (1969) suggested that a nominal zero interest rate is necessary condition for optimal allocation of resource. It was found that zero interest rate is required and sufficient for allocative efficiency by investigation within general equilibrium models (Wilson, 1979; Cole and Kocherlakota, 1998). Literature also supported that interest-free (profit and loss sharing) system is viable and superior to an interest-based system (Chapra, 1985; Mirakhor, 1997). It is reported that Islamic banks perform better as compared to conventional banks due to higher perception of service quality in Pakistan (Ahmad et al., 2010). Similarly, a stronger positive relationship is reported between service quality and customer satisfaction among customers of Islamic banks (Ahmad, Rehaman and Saif, 2010). Al-Jarhi and Iqbal (2001) defined Riba with reference to Sharia'h scholars as “anything (big or small), pecuniary or non-pecuniary, in excess of the principal on a loan that must be paid by the borrower to the lender along with the principal as a condition (stipulated or by the custom), of the loan or for an extension in its maturity.” It is referred as Riba-al-qard or Riba-al-Quran that is known as interest on loans in recent age. Islam prohibits all types of Riba not only on loans but also on other transactions as Riba-al-fadl that is linked with an exchange of commode-ties. Similarly, interest is prohibited on all type of activities that is, whether it is paid/received on consumption or production activities. Most interestingly, it was also reported that the performance of Islamic banks meets the international standards in terms of profitability (Iqbal et al., 1998). Table 2 reveals the definition of terms used in this study.