Islamic or conventional savings: what is the difference?

Lanternvale Bank offers both conventional and Islamic savings accounts, and customers often ask us how they really differ. On a banking app the two can look almost identical: a balance, a percentage and a monthly statement. Underneath, they rest on different contracts and different ideas about how money should earn a return.

How a conventional savings account works

In a conventional account, you lend your money to the bank. The bank promises to pay you interest for the use of that money, whatever happens to its own investments. Our Regular Savings Account earns interest at a fixed rate of 3.25% p.a., calculated on your balance and paid every quarter. The return is agreed in advance and does not depend on how the bank performs.

How an Islamic savings account works

Islamic finance does not permit interest, known as riba. Instead, an Islamic savings account is usually built on a partnership called Mudaraba. You provide the capital, and the bank acts as the manager, called the Mudarib, investing the pooled funds in Sharia-compliant activities. When those investments make a profit, it is shared according to a ratio agreed at the start.

In our Mudaraba Savings Account the ratio is 70% to the customer and 30% to the bank. We publish an expected profit rate of 3.40%, which is not guaranteed. If the investment pool performs better, your share can be higher. If it performs worse, your share can be lower, and in the rare event of a genuine loss that is not caused by the bank's negligence, capital can be affected.

What about fixed-term options?

For money you can leave untouched, the conventional choice is a term deposit with a fixed rate. The Islamic choice is often a Wakala Investment Deposit. Under Wakala, you appoint the bank as your agent to invest your money for 3, 6 or 12 months. The bank announces an expected profit, such as 5.20% for 12 months, and keeps any profit above that level as its agency fee.

Side by side

• Contract: conventional is a loan to the bank; Mudaraba is a profit-sharing partnership.
• Return: conventional pays agreed interest; Islamic accounts share actual profit at an agreed ratio.
• Certainty: interest is contractually fixed; expected profit rates are indications, not promises.
• Oversight: Islamic products are reviewed by a Sharia supervisory board.
• Use of funds: Islamic funds cannot be invested in prohibited activities.

Which should you choose?

For many customers the decision is a matter of faith, and the Islamic account is the natural choice. Others simply compare features. Both accounts at Lanternvale Bank have similar opening amounts, the same app and the same access to your money. If certainty of return matters most, a conventional account offers that. If you want your savings linked to real, ethical investment and are comfortable with a return that can vary, Mudaraba may suit you.

Whichever you pick, the habits that matter most are the same: save regularly, keep an emergency fund you can reach and review your goals once a year.

Lanternvale Bank is fictional and this article is written for software testing. It is not religious or financial advice.