A BRIEF HISTORY OF ISLAMIC BANKING money, profit, finance-2696219.jpg

A BRIEF HISTORY OF ISLAMIC BANKING

A BRIEF HISTORY OF ISLAMIC BANKING

Islamic finance is a system that operates in observance of Islamic law or commonly referred to as Sharia principles. Although contemporary media sources and academic writers describe Islamic banking in many ways, Islamic banking is in essence the group of financial activities based on a set of Islamic rules governing transactions known as Fiqh al-Muamalat. The basic tenant of the Islamic value proposition is a prohibition on paying and receiving of interest (riba), and a fundamental belief in the sharing of profit and risk (mudharabah) in the conduct of business. In summary, Islamic banking fulfils the same basic intention as conventional banking. However, Islamic banking operates in accordance with an overall set of guiding principles based on common Islamic concepts described in the Holy Quar’an and the Sunnah such as profit sharing (mudharabah), safekeeping (wadiah), joint venture (musyarakah), cost plus (murabahah), leasing (ijarah) and the prohibition of interest (riba).

These concepts representative of Islamic banking are not new. For many centuries, Muslim societies living in nations in all parts of the world have strived to developed ways to assimilate their religious values within the economic and banking activities of the nations in which they live. The process of assimilation follows two distinct paths: a liberal or non-interventionist approach, whereby Islamic values are seen as compatible with modern secular institutions and law within certain limits, or a conservative traditionalist approach, where the expressed goal is to produce a true Islamic society and subsequent monetary system. In today’s global economy, the vast majority of Muslims fall within a gradient of tolerance between these two paths.

In the last four decades, Muslim bankers and religious leaders worked to fashion financial instruments similar to today’s ethical investing as a means to conform to Islamic law. Two key concepts acted as motivating factors to form both the financial products themselves and in many cases the fundamentals of the institutions in which they operated: Islamic revivalism and a practical response to problems of debt. Islamic revivalism as argued by Timur Kuran reflects a desire to promote the beliefs of an Islamic identity, which in turn acts as a catalyst to shape the financial products up to and including the present day. The momentum of Islamic revivalism coupled with the rising economies of the Gulf region has led to the emergence of a greater demand for more ethically based economic system bound within a regulatory system that is driven by religious principles.

If one considers Islamic banks in their historical context, one can clearly see that they follow a similar progression to conventional banking in that they were established like other banks to provide a service that is valued by the communities they serve. For example, in the sixteenth century, inns in the Netherlands evolved into the facilitators of trade and commerce not by choice, but because merchants realized that they were located at the nexus of the road and canal systems and found them a convenient place to leave money and goods for safekeeping and exchange. Such is with Islamic banking, with initial undertaking in the 1950s establish an Islamic financial institution Pakistan and 1960s, the establishment of banks such as the Mit Ghamr Savings Bank in a rural area of the Nile Delta and Perbadanan Wang Simpanan Bakal-Bakal Haji in Malaysia.

According to Rodney Wilson, the Pakistani experiment was initiated by local property owners who loaned money to smaller landowners to supply them with the necessary capital for agriculture, which was repaid without interest with an added charge to cover the bank’s operating expenses. The clear value proposition of this initial foray into Islamic banking exhibited great success while it simultaneously contributed to its ultimate failure. As Wilson points out that, the bank’s failure is attributed to two fundamental problems: unrealistic forecasting on the demand for capital and lack of autonomy by the bank over its own operation as property owners played too active a role in lending decisions. In the Pakistani case, the value proposition for Islamic banking was compelling, clearly understood by the landowners who needed capital for their operations.

A BRIEF HISTORY OF ISLAMIC BANKING money, profit, finance-2696219.jpg

The Egyptian Mit Ghamr Savings Bank venture into Islamic banking in the 1960s also achieved great initial success growing from a single rural location to a network of branches having the same clear value proposition with one variation: borrowers had to have some level of deposits in the bank to get a loan. A change in the nation’s political environment severely retarded its operations until 1971, when the bank re-emerged as the Cair-based Nasser Social Bank providing services to assist social concerns such as small projects and higher education for economically disadvantaged students.

A BRIEF HISTORY OF ISLAMIC BANKING

In Malaysia, the value proposition for Islamic banking was brought about by a fundamental need to save for expenses during their pilgrimage to Mecca. In order to accumulate monies for their pilgrimage, Muslims in Malaysia typically saved by accumulating livestock, property and other goods until the time they were ready to travel and subsequently sold them to raise sufficient funds to make the journey. This practice was damaging to the family finances, the rural economy and national economic growth. Even after several name changes and merged operations, Lembaga Tabung Haji’s value proposition remains the same after forty years.

In the 1970s a number of Islamic institutions formed, such as Dubai Islamic Bank, Islamic Development Bank, Islamic Investment Company, Islamic Banking System International Holding (Luxembourg), Islamic Finance House, Islamic Bank International of Denmark, Dar-al-mal-al-Islami (Geneva) and Kuwait Finance House (to name a few). The list continued to grow slowly throughout the Middle East during the 1980s, with the granting of an Islamic bank license in Saudi Arabia to the fifty-year old Al-Rajhi Company creating the Al-Rajhi Banking Investment Corporation.

In 1974, long before Islamic banking became a area of study unto itself, the Union of Arab Banks (UAB) identified that one of the weaker aspects of the Islamic banking value proposition is a lack of clear standards. The UAB was founded to foster cooperation between member banks, coordinate activities, and to act as a central source for Arab common economic practice.

The turning point for Islamic banking was the establishment of the Islamic Development Bank (IDB) in 1975, whereby, this event began the journey during the next 30 years where Islamic banking became a strong and viable alternative model for financial intermediation.

Islamic banking today is at the centre of a media hype. Some of us have great hopes for this system of fair, profit and risk sharing banking, and we ponder whether non-Muslims will be equally as attracted to this form of banking. It can be said that even if the world does not change from an interest-based to an equity-profit based economy for global commerce and finance, the future of Islamic banking presents Muslims with an opportunity to demonstrate the power of their values. Islamic banks are renowned for caring and investing on the communities that they serve, profit being an important but not the only determining factor in choosing products and services offered to the population. As Islamic banks expand their pallet of services to address the financial needs of all customers, one thing is clear: the next ten years will be an exciting time for Islamic banking.

To unleash the potential of emerging markets, Islamic banks must become the catalyst of economic change by developing new products and services that best serve the ever-changing needs of people and small businesses. Unlike their western counterparts, banks in Muslim nations provide economic and social cohesion which acts to stimulate economic development through programmes such as microfinancing, SME lending, and the creation of capital markets for medium sized enterprises. The vision for all banks in emerging markets is to go beyond simply replicating conventional banking products. The history of Islamic banking is not finished; we are amidst an evolutionary process in which Islamic banks will adapt to meet the needs of a nation state, the communities that they serve, and the people within these communities.

 

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