What is Islamic Finance ?
Islamic Banking (Or Participant Banking) (Arabic: المصرفية الإسلامية) Is Banking Or Banking Activity That Is Consistent With The Principles Of Islamic Law (Sharia) And Its Practical Application Through The Development Of Islamic Economics. Sharia Prohibits The Fixed Or Floating Payment Or Acceptance Of Specific Interest Or Fees (Known As Riba Or Usury) For Loans Of Money. Investing In Businesses That Provide Goods Or Services Considered Contrary To Islamic Principles Is Also Haraam(Forbidden). While These Principles May Have Been Applied To Historical Islamic Economies, It Is Only In The Late 20th Century That A Number Of Islamic Banks Were Formed To Apply These Principles To Private Or Semi-Private Commercial Institutions Within The Muslim Community.
History Of Islamic Banking
An Early Market Economy And An Early Form Of Mercantilism Were Developed Between The 8th-12th Centuries, Which Some Refer To As "Islamic Capitalism". The Monetary Economy Of The Period Was Based On The Widely Circulated Currency The Dinar, And It Tied Together Regions That Were Previously Economically Independent.
A Number Of Economic Concepts And Techniques Were Applied In Early Islamic Banking, Including Bills Of Exchange, Partnership (Mufawada) Such As Limited Partnerships (Mudaraba), And Forms Of Capital(Al-Mal), Capital Accumulation (Nama Al-Mal), Cheques, Promissory Notes, Trusts, Transactional Accounts, Loaning, Ledgers And Assignments. Organizational Enterprises Independent From The State Also Existed In The Medieval Islamic World, While The Agency Institution Was Also Introduced During That Time.Many Of These Early Capitalist Concepts Were Adopted And Further Advanced In Medieval Europe From The 13th Century Onwards.
The Word "Riba" Means Excess, Increase Or Addition, Which According To Shariah Terminology, Implies Any Excess Compensation Without Due Consideration (Consideration Does Not Include Time Value Of Money). The Definition Of Riba In Classical Islamic Jurisprudence Was "Surplus Value Without Counterpart", Or "To Ensure Equivalency In Real Value", And That "Numerical Value Was Immaterial."
Applying Interest Was Acceptable Under Some Circumstances. Currencies That Were Based On Guarantees By A Government To Honor The Stated Value (I.E. Fiat Currency) Or Based On Other Materials Such As Paper Or Base Metals Were Allowed To Have Interest Applied To Them.When Base Metal Currencies Were First Introduced In The Islamic World, The Question Of "Paying A Debt In A Higher Number Of Units Of This Fiat Money Being Riba" Was Not Relevant As The Jurists Only Needed To Be Concerned With The Real Value Of Money (Determined By Weight Only) Rather Than The Numerical Value. For Example, It Was Acceptable For A Loan Of 1000 Gold Dinars To Be Paid Back As 1050 Dinars Of Equal Aggregate Weight (I.E., The Value In Terms Of Weight Had To Be Same Because All Makes Of Coins Did Not Carry Exactly Similar Weight).
Modern Islamic Banking
Interest-Free Banking Seems To Be Of Very Recent Origin. The Earliest References To The Reorganisation Of Banking On The Basis Of Profit Sharing Rather Than Interest Are Found In Anwar Qureshi (1946), Naiem Siddiqi (1948) And Mahmud Ahmad (1952) In The Late Forties, Followed By A More Elaborate Exposition By Mawdudi In 1950. The Writings Of Muhammad Hamidullah 1944, 1955, 1957 And 1962 Should Be Included In This Category.They Have All Recognised The Need For Commercial Banks And Their Perceived "Necessary Evil," Have Proposed A Banking System Based On The Concept Of Mudarabha - Profit And Loss Sharing.
In The Next Two Decades Interest-Free Banking Attracted More Attention, Partly Because Of The Political Interest It Created In Pakistan And Partly Because Of The Emergence Of Young Muslim Economists. Works Specifically Devoted To This Subject Began To Appear In This Period. The First Such Work Is That Of Muhammad Uzair (1955).Another Set Of Works Emerged In The Late Sixties And Early Seventies. Abdullah Al-Araby (1967), Nejatullah Siddiqi (1961, 1969), Al-Najjar (1971) And Baqir Al-Sadr (1961, 1974) Were The Main Contributors.
The Early 1970s Saw Institutional Involvement. The Conference Of The Finance Ministers Of The Islamic Countries Held In Karachi In 1970, The Egyptian Study In 1972, The First International Conference On Islamic Economics In Mecca In 1976, And The International Economic Conference In London In 1977 Were The Result Of Such Involvement. The Involvement Of Institutions And Governments Led To The Application Of Theory To Practice And Resulted In The Establishment Of The First Interest-Free Banks. The Islamic Development Bank, An Inter-Governmental Bank Established In 1975, Was Born Of This Process.
The First Modern Experiment With Islamic Banking Was Undertaken In Egypt Under Cover Without Projecting An Islamic Image—For Fear Of Being Seen As A Manifestation Of Islamic Fundamentalism That Was Anathema To The Political Regime.The Pioneering Effort, Led By Ahmad Elnaggar, Took The Form Of A Savings Bank Based On Profit-Sharing In The Egyptian Town Of Mit Ghamr In 1963. This Experiment Lasted Until 1967 (Ready 1981), By Which Time There Were Nine Such Banks In Country.In 1972, The Mit Ghamr Savings Project Became Part Of Nasr Social Bank Which, Currently, Is Still In Business In Egypt. In 1975, The Islamic Development Bank Was Set Up With The Mission To Provide Funding To Projects In The Member Countries. The First Modern Commercial Islamic Bank, Dubai Islamic Bank, Opened Its Doors In 1975. In The Early Years, The Products Offered Were Basic And Strongly Founded On Conventional Banking Products, But In The Last Few Years The Industry Is Starting To See Strong Development In New Products And Services.
Islamic Banking Is Growing At A Rate Of 10-15% Per Year And With Signs Of Consistent Future Growth.Islamic Banks Have More Than 300 Institutions Spread Over 51 Countries, Including The United States Through Companies Such As The Michigan-Based University Bank, As Well As An Additional 250 Mutual Funds That Comply With Islamic Principles. It Is Estimated That Over US$822 Billion Worldwide Sharia-Compliant Assets Are Managed According To The Economist.This Represents Approximately 0.5% Of Total World Estimated Assets As Of 2005.According To CIMB Group Holdings, Islamic Finance Is The Fastest-Growing Segment Of The Global Financial System And Sales Of Islamic Bonds May Rise By 24 Percent To $25 Billion In 2010.
Addressing The Oman Investment Forum In October 2011, All Conventional Banks In Oman Can Offer Sharia-Based Financial Services Upon Approval From The Central Bank Of Oman (CBO).
The Vatican Has Put Forward The Idea That "The Principles Of Islamic Finance May Represent A Possible Cure For Ailing Markets.Largest Islamic BanksShariah-Compliant Assets Reached About $400 Billion Throughout The World In 2009, According To Standard & Poor’s Ratings Services, And The Potential Market Is $4 Trillion. Iran, Saudi Arabia AndMalaysia Have The Biggest Sharia-Compliant Assets.
In 2009 Iranian Banks Accounted For About 40 Percent Of Total Assets Of The World's Top 100 Islamic Banks. Bank Melli Iran, With Assets Of $45.5 Billion Came First, Followed By Saudi Arabia's Al Rajhi Bank, Bank Mellat With $39.7 Billion And Bank Saderat Iran With $39.3 Billion. Iran Holds The World's Largest Level Of Islamic Finance Assets Valued At $235.3bn Which Is More Than Double The Next Country In The Ranking With $92bn. Six Out Of Ten Top Islamic Banks In The World Are Iranian. In November 2010, The Banker Published Its Latest Authoritative List Of The Top 500 Islamic Finance Institutions With Iran Topping The List. Seven Out Of Ten Top Islamic Banks In The World Are Iranian According To The List.
History and evolution of Islamic Finance
It seems that the history of interest-free banking could be divided into two parts. First, when it still remained an idea; second, when it became a reality -- by private initiative in some countries and by law in others. We will discuss the two periods separately. The last decade has seen a marked decline in the establishment of new Islamic banks and the established banks seem to have failed to live up to the expectations. The literature of the period begins with evaluations and ends with attempts at finding ways and means of correcting and overcoming the problems encountered by the existing banks.
Interest-free banking as an idea
Interest-free banking seems to be of very recent origin. The earliest references to the reorganisation of banking on the basis of profit sharing rather than interest are found in Anwar Qureshi (1946), Naiem
Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, followed by a more elaborate exposition by Mawdudi in 1950 (1961).2 Muhammad Hamidullah’s 1944, 1955, 1957 and 1962 writings too should be
included in this category. They have all recognised the need for commercial banks and the evil of interest in that enterprise, and have proposed a banking system based on the concept of Mudarabha - profit and loss sharing.In the next two decades interest-free banking attracted more attention, partly because of the political
interest it created in Pakistan and partly because of the emergence of young Muslim economists. Works specifically devoted to this subject began to appear in this period. The first such work is that of
Muhammad Uzair (1955). Another set of works emerged in the late sixties and early seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar (1971) and Baqir al-Sadr (1961, 1974) were the main contributors.Early seventies saw the institutional involvement. Conference of the Finance Ministers of the Islamic Countries held in Karachi in 1970, the Egyptian study in 1972, First International Conference on Islamic Economics in Mecca in 1976, International Economic Conference in London in 1977 were the result of
such involvement. The involvement of institutions and governments led to the application of theory to practice and resulted in the establishment of the first interest-free banks. The Islamic Development Bank, an inter-governmental bank established in 1975, was born of this process.
The coming into being of interest-free banks
The first private interest-free bank, the Dubai Islamic Bank, was also set up in 1975 by a group of Muslim businessmen from several countries. Two more private banks were founded in 1977 under the name of
Faisal Islamic Bank in Egypt and the Sudan. In the same year the Kuwaiti government set up the Kuwait Finance House.However, small scale limited scope interest-free banks have been tried before. One in Malaysia in the mid-forties4 and another in Pakistan in the late-fifties.5 Neither survived. In 1962 the Malaysian government set up the “Pilgrim’s Management Fund” to help prospective pilgrims to save and profit.6 The
savings bank established in 1963 at Mit-Ghamr in Egypt was very popular and prospered initially and then closed down for various reasons.7 However this experiment led to the creation of the Nasser Social Bank in 1972. Though the bank is still active, its objectives are more social than commercial.In the ten years since the establishment of the first private commercial bank in Dubai, more than 50 interest-free banks have come into being. Though nearly all of them are in Muslim countries, there are some in Western Europe as well: in Denmark, Luxembourg , Switzerland and the UK. Many banks were established in 1983 (11) and 1984 (13). The numbers have declined considerably in the following years.In most countries the establishment of interest-free banking had been by private initiative and were confined to that bank. In Iran and Pakistan, however, it was by government initiative and covered all banks in the country. The governments in both these countries took steps in 1981 to introduce interest-free banking. In Pakistan, effective 1 January 1981 all domestic commercial banks were permitted to accept
deposits on the basis of profit-and-loss sharing (PLS). New steps were introduced on 1 January 1985 to formally transform the banking system over the next six months to one based on no interest. From 1 July
1985 no banks could accept any interest bearing deposits, and all existing deposits became subject to PLS rules. Yet some operations were still allowed to continue on the old basis. In Iran, certain administrative
steps were taken in February 1981 to eliminate interest from banking operations. Interest on all assets was replaced by a 4 percent maximum service charge and by a 4 to 8 percent ‘profit’ rate depending on the
type of economic activity. Interest on deposits was also converted into a ‘guaranteed minimum profit.’ In August 1983 the Usury-free Banking Law was introduced and a fourteen-month change over period began
in January 1984. The whole system was converted to an interest-free one in March 1985
The last decade
The subject matter of writings and conferences in the eighties have changed from the concepts and possibilities of interest-free banking to the evaluation of their performance and their impact on the rest of
the economy and the world. Their very titles bear testimony to this and the places indicate the world-wide interest in the subject. Conference on Islamic Banking: Its impact on world financial and commercial
practices held in London in September 1984, Workshop on Industrial Financing Activities of Islamic Banks held in Vienna in June 1986, International Conference on Islamic Banking held in Tehran in June
1986, International Conference on Islamic Banking and Finance: Current issues and future prospects held in Washington, D.C. in September 1986, Islamic Banking Conference held in Geneva in October 1986,and Conference ‘Into the 1990’s with Islamic Banking’ held in London in 1988 belong to this category.The most recent one is the Workshop on the Elimination of Riba from the Economy held in Islamabad in April 1992.Several articles, books and PhD theses have been written on Islamic Banking during this period. Special mention must be made of the work by M. Akram Khan in preparing annotated bibliographies of all
published (and some unpublished) works on Islamic Economics (including Islamic Banking) from 1940 and before. It is very useful to students of Islamic Economics and Banking, especially since both English
and Urdu works are included (1983, 1991, 1992). M.N. Siddiqi’s bibliographies include early works in Arabic, English and Urdu (1980, 1988). Turkish literature is found in Sabahuddin Zaim (1980).