EVOLUTION OF ISLAMIC INTEREST-FREE BANKING

Commercial banking came into existence out of the desire of traders, entrepreneurs and manufacturers to expand their business beyond what their financial resources can cater for. Hence, a system has to be devised to channel money from those who have in excess but have no immediate need for it to those who needs money but do not have enough to carry on trading acivities.

Borne out of the need to access funds due to their growing business and the need shun interest based transactions in its entirety, muslim traders went into partnerships (mudarabah) and this dominated the muslim business world for centuries.

When the muslim world came into contact with industrialization and commercial banking system, they had the choice of either accepting the system and arguing that interest charged by those institution do not contain element of riba or try to develop an alternative system that adheres to the tenets of Islamic shari’ah.

The option of developing an alternate shari’ah compliant system was difficult as the economy of the Muslim countries were managed by colonial powers and they therefore have little or no say in the political and economic systems.

Islamic scholars in Egypt started attempting to develop an interest free Islamic banking system since the 1890s but they had no break through until 1963 when Dr Ahmad An-Najjar whose key principle was profit sharing, started the collection of personal savings from people and investing them in an Islamic system that apportions profits according to the signed agreement between both parties in the Egyptian town of Mit Ghamr. The banks neither charged nor paid interest but their activities were mostly limited to trade and industries where these banks invested directly or as partners of depositors. Hence, functionally these banks were working more as financial institutions rather commercial banks. The Mit Ghamr project which made a good start was later abandoned for political reasons.

Part of the difficulties that arose initially was how Islamic banks would provide all the modern commercial banking services without the inclusion of interest. Using traditional Islamic law, it became possible to apply Islamic law to conventional banking operations by people who had deep knowledge and significant economic and financial work experience.

In 1972, The Mit Ghamr Savings project became part of Nasser Social Bank which is still in business. It is the first Islamic Bank in an urban setting and its main purpose is to grant interest free loans. Funds are provided from extra-budgetary resources, appropriation from state budget and contributions from the Ministry of Auqf.

The first private modern commercial Islamic bank to be established was the Dubai Islamic Bank. It opened its doors for commercial activities in 1975. In the early years, only conventional products were offered, but in the last few years, the industry has seen strong development in products and services.

The Islamic Development Bank was set up in 1975 to function in accordance with Shari’ah and to bridge the gap between the rich and the poor member countries in the Muslim world.

In 1977, Faisal Islamic bank of Egypt and Sudan, and Kuwait Finance House were established as private banks. In 1981, Dar al-Maal al-Islami Trust and the Al-Baraka Group were established and they control a number of Islamic banks, Islamic Investment companies and Islamic insurance companies

The true phase of development of Islamic financial institutions actually occurred in the 1980s. Earlier initiatives were more inclined towards interest free Islamic banking, but the emergence of financial systems has evolved in the 80s. However, non-payment of interest still remains the pivotal part of Islamic banking, whereas principles of Islamic finance such as property rights, sanctity of contracts and the rules of sharing risk are also supported. During this era, efforts were made to implement Islamic banking on a country-wide basis in Pakistan, Sudan and Iran.

Islamic banking system is no longer restricted to its Middle East origin and stronghold as western nations e.g. UK, USA, Singapore, Brunei etc. are striving to become global centers for Islamic Finance.  A number of conventional banks have opened Islamic Banking windows and offer their customers a number of Islamic Financial product and services.

With the recent economic meltdown in the western world, the world has been more informed of the harms of usury practiced by conventional banks and focus is shifting towards Non-Interest mode of banking.

The Vatican said banks should look at the rules of Islamic finance to restore confidence amongst their clients at a time of global economic crisis. It continued that: “The ethical principles on which Islamic finance is based may bring banks closer to their clients and to the true spirit which should mark every financial service,”

-         the Vatican’s official newspaper Osservatore Romano

With the growth of Islamic finance, a number of standard setting bodies and agencies were brought to the fore to regulate the practices. While the Islamic Development Bank plays a pivotal role in developing internationally acceptable standards and procedure, several others are working to set shari’ah-compliant standards across nations. They include: Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI); Islamic Financial Services Board (IFSB); International Islamic Financial Market (IIFM); Liquidity Management Centre (LMC) and International Islamic Ratings Agency (IIRA).

Aside from the islamic banking, conventional insurance as practiced in the west is not acceptable and that has brought about takaful- the Islamic alternate to insurance which has sought to eliminate all elements of uncertainty (gharar), gambling (maysir) and interest (riba)