Islamic Banking - An Overview

"O You believe! Fear Allah and give up that remains of your demand for usury (interest), if you are indeed believers." -The Quran

INTRODUCTION:

All religions have their own sets of Divine values and norms with regard to human behavior at large, the economic behavior being a part of it. They all call on human beings to observe and implement religious guidance both individually and collectively for the well being of the nation.

The basic principles of Islamic Banking originate in the axioms of justice and harmony with reality and the human nature. The concept of Islamic Banking is evolved on the basis of Shariah principles. One might wonder whether Islamic Banking & Finance is an alternative approach to modern banking.

The most important development in modern banking is the art of mobilizing funds for investment. It happened to be that the method of both collecting and using of funds was based in the West on the interest paid and charged. In contrast Islamic Banking is a system that provides financing and attracts savings on the basis of profit and Loss sharing. The Central feature of Islamic Banking is that no interest would be charged or paid and the returns would be in the form of profits from trade in which the money lent or borrowed is invested. For Muslims this system of Profit or Loss sharing coincides with their prohibition of interest, and helps in mobilizing unused funds for investment and creating new job opportunities. As for non-Muslims, the Islamic Banking system doesn't contradict their faith, while it provides the society with alternative ideas for venture capital and other tools of investment.

EVOLUTION

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 which was anathema of the political regime. The pioneering effort, led by Ahmad El Najjar took the form of a savings banks based on profit sharing in the Egyptian town of Mit Ghamir in 1963.This experiment lasted until 1967 by which time there were 9 such banks in the country. These banks which neither charged nor paid interest invested mostly by engaging in trade and industry directly or in partnership with others and shared their profits with the depositors. Thus they functioned essentially as savings investment institutions rather then as commercial banks.

GROWTH OF ISLAMIC BANKS:

Pre Islamic Arabia

The early days of man was very simple and was not so sophisticated as that of today. His needs were simple and the trade was direct. It involved exchange of goods for goods. This was popularly known as the barter system which was prevalent world wide . There was no common measure of value and no common medium of exchange.

Due to inconveniences in the barter system, the need for a common measure of value gave birth to money in the form of coins and later in the form of currencies. In Islamic Arabia there was no barrier to the type of goods produced including wine. Interest on money was accepted and there was no divine definitions to formats of trade.

Prophetic Introduction

There was a lot of religious definitions in each and every aspect of trade after the Prophetic introduction. There were many procedures that was completely adhered to such as:

o Interest free Debt

o Encouraging economic mobility and not hoarding

o Prohibiting manufacture of wine and restrictions placed on gambling

o Creating a Tax framework

A quick reading of Islamic history tells us that practices of certain forms of banking activities go back as early as1200 years ago in Baghdad, Damascus etc. However the early contemporary Islamic banking institutions came in the first part of 1960's with the Pilgrims Fund and the Mit Ghamt Savings Bank 1963 in Egypt. Though the experiment was localized it attracted a large number of clients and generated a lot of popular enthusiasm.

According to the International Association of Islamic Banks, the number of Islamic Banks and financial institutions registered with it has reached 186 in late 1995 out of which statistical information is available on about 144. Looking at the geographical dispersion we observe that 47 Islamic banks and financial institutions are established in South Asia, 30 in Africa, 24 in South East Asia, 22 in the Middle East , 17 in the GCC* countries and 4 in Europe and America. The financial indications show that in 1995, the total capital of the 144 banks is slightly above US$ 6 billion, total assets reached US$166 billion, reserves are around US$ 3 billion and net profits reached nearly US$ one and a quarter billion

PRINCIPLES OF ISLAMIC BANKING:

o Interest free

o Multipurpose and not purely commercial

o Equity oriented

o PLS- Profit Loss Sharing

o Purchase stock on behalf of a client and sell it to him at a profit over the purchase price

PROBLEMS, ISSUES AND CHALLENGES

o The gap between Islamic Banking Model and its application

o A misconception that Islamic Finance is essentially communist in nature and there is no room for innovation.

o PLS (Profit Loss Sharing) not suitable for short-term financing or for non-profit sector

o Lack of Legal and institutional framework that facilitates appropriate contracts as well as regulatory mechanisms to enforce them

o The lack of adequate range of financial instruments to meet the varying needs of investment.

* GCC-Gulf Cooperation Council

REVIVIAL

Islamic financial institutions have undergone tremendous changes over the years and the aim of these financial institutions is Globalization. They have simplified the procedures for lending credit and have formulated new innovations such as funding interest free educational loans and creating acceptable formats of contracts.

CONCLUSION

Though Islamic Banking is still in the development stage, it has gained popularity and acceptance by many countries including the West, as many banks like HSBC and Citigroup are planning to offer their services for their Muslim customers. Islamic banking and financial Institutions are very popular in Bangladesh. It has been described by a Bahrain based General Council for Islamic Banks and financial institutions as one of the fastest growing and the most innovative financial industries in the international capital markets.

R. GAYATHRI SARAVANAN, M.A M.PHIL

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