Risk, profit, and partnership: How Islamic banking differs from the traditional interest – based model

With the Senate’s recent approval of legislation permitting Islamic banking operations, Uzbekistan is entering a new era of financial diversity. As the concept remains relatively new to many citizens, Kun.uz spoke with Jahongir Imomnazarov, an expert with over 30 years of experience in finance and a specialist in Islamic banking since 2011, to clarify how these two systems compare.

The shared purpose of banks

Regardless of their model, the fundamental role of any bank is to serve as a financial intermediary. They collect idle funds from the public and businesses and redistribute them to those in need of capital, thereby fueling economic growth. "Money must circulate in the economy to drive progress," Imomnazarov explains, noting that modern banking, whether through plastic cards or digital transfers, is essential for this velocity.

Revenue models: Interest vs. Trade

The primary distinction lies in how these institutions generate income. While both earn "non-interest" income through service fees (such as money transfers, currency exchange, or safekeeping), their core financing methods differ significantly:

Traditional banks: Operate on a creditor–debtor relationship. They attract deposits by promising a guaranteed interest rate (e.g., 20% per year) and lend those funds to businesses at a higher rate (e.g., 24%–30%). The bank earns the margin regardless of whether the borrower's business succeeds or fails.
Islamic banks: Operate on a buyer–seller or partner–partner relationship. Instead of lending cash at interest, the bank may purchase an asset for the client and sell it back with a markup (trade) or enter into a profit–and–loss sharing agreement.

Risk sharing and "Mudarabah"

In Islamic finance, the concept of risk is central. Under the principle of Mudarabah (profit-sharing), the bank provides the capital while the client provides the expertise. If the venture generates a profit, it is shared according to a pre-agreed ratio.

Unlike traditional deposits, Islamic banks cannot guarantee a fixed return. "An Islamic bank might suggest a projected return of 20%, but this is a target, not a contractual guarantee," Imomnazarov notes. This aligns with the Islamic legal maxim: "The entitlement to profit is justified by the assumption of risk."

Addressing costs and "Halal" services

A common question among consumers is why Islamic financial products often appear more expensive than traditional ones. Imomnazarov points to two main factors:

Commercial nature: Islamic banks are profit-seeking institutions, not charities. They bear higher risks by taking ownership of assets before selling them to clients.
Market maturity: The sector in Uzbekistan is in its infancy. With limited capital and low competition, prices remain high. As more players enter the market, competition is expected to drive costs down.

The importance of financial literacy

As these new options become available, experts urge the public to exercise caution and diligence. Whether dealing with a traditional or Islamic institution, the advice remains the same: read every contract carefully.

"Financial literacy is vital," Imomnazarov emphasizes. "Signing a document without understanding it can lead to unexpected penalties or high costs. If you do not understand the terms, consult a specialist before committing."