History of Islamic Banking

Discover the History of Islamic Banking

History of Islamic Banking

Without a doubt, the history of Islamic Banking is quite interesting. Since the medieval era (1,000 – 1,500 AD), businesspeople in the Middle East engaged in financial transactions. At this time though, these transactions used the same financial principles as the Europeans.

Early History of Islamic Banking

Since the Arabs of the Ottoman Empire traded extensively with people in Spain, they also developed certain no-interest financial systems that worked on a profit and loss sharing method. These systems, in turn, financed trade and other business affairs.

When the Middle Eastern and Asia began to be more important trading partners for various European companies, the Europeans opened banks in these countries – with many of these banks based on the interest-bearing financial system.

As the trading relationship with the Europeans continued to play an important role, these types of financial institutions began to be more prominent outside of Europe. However, even when local trading business owners used these commercial banks, they often only transferred money between accounts. Both borrowing and depositing money was limited as the local population wanted to refrain from partaking in interest-bearing transactions. Further, certain co-operative institutions based on the original profit and loss sharing model still existed, but only in certain locations.

As economic demands increased, avoiding banks was not an option for local business people any longer. As such, local banks with an interest-based model expanded in the area. Further, as countries became independent from colonial rule, the need for banks became more important than ever. Whether the citizens liked the system or not, individuals, companies and governments had to use these types of banks. To offer a more palatable choice, some experts proposed an interest-free banking alternative.

Growth of Islamic Banking

In the following decades, interest in this type of banking continued to grow substantially. Soon, the first widely recognized financial institution – the Mit Ghamr savings project in Egypt opened for business. A co-operative organization, all depositors could also obtain small loans for practical productive reasons. Additionally, this co-operative also invested in certain projects on a profit sharing basis. In 1971, this project was incorporated with the Nasser Social Bank.

Additionally, well-respected conferences such as the Finance Ministers of the Islamic Countries, the First International Conference on Islamic Economics debated Islamic financing. As a consequence, the application of interest-free banking from simply a theory to actual practice occurred – and in 1975, an intergovernmental bank was created. In that same year, the first privately owned interest free bank – called the Dubai Islamic Bank also opened with more banks opening after that in countries such as Sudan, Egypt, and Kuwait.

Since 1975, over fifty interest-free banks opened with the majority of these financial institutions being in Muslim countries. That said, Islamic banks also opened in Western Europe during the early 1980s. In addition, the governments of both Pakistan and Iran implemented an Islamic banking system in all of the banks.


Islamic Banking Today

Growing at a rate of ten to fifteen percent on an annual basis since the late 1990s, these types of financial institutions continue to flourish as patrons recognize the benefits these banks offer. Further, the number of banks that offer Islamic financial services continues to grow – and even some conventional banks offer Islamic financing options. Thus, Islamic banks do offer an appealing alternative to the more traditional commercial banking system. Sharia structuring and consulting companies, such as ijaraloans.com have grown dramatically over the past decade to become a convenience source of Islamic Finance solutions for Muslim consumers.

Modern Islamic Financing : The first Islamic bank was established in Egypt in 1964, but the first to be explicitly based on Sharia principles was created by the Organization of Islamic countries (OIC) in 1974. Islamic banks continued to proliferate throughout the 80s and 90s and today the Islamic finance market is growing at an average annual rate of 10 – 15% a year – and show no signs of slowing down. Sharia law provides an ethical framework for these financial institutions which emphasizes economic well-being and individual development as well as values such as fairness, honesty, and generosity. These Shariah compliant institutions also avoid interest, risk, and speculation.

Islamic financing institutions have developed numerous methods for establishing Shariah-compliant home purchasing and investment vehicles.

Ijara: The Ijara-wa-Iqutina (lease and ownership) Islamic home finance method establishes a rent-to-own agreement which turns the customer into a renter. The Ijarah process creates a Trust which purchases the property and leases it to the home’s inhabitants. When the customer is ready to move, the Trust must sell the home to the customer under the terms of a promise to purchase.

“The Ijara process has been used in the U.S. for more than 20 years,” explains Shoeb Sharieff, whose company, IjaraLoans.com, was the first to offer Shariah compliant financial solutions in all 50 states. “And Ijara loans conform with U.S. banking regulations and the Truth in Lending Act.”

Musharaka: In a Musharaka finance transaction, the bank or financial institution creates a joint venture partnership with the customer rather than establishing a creditor/debtor agreement. When used for Islamic home finance, a Musharaka is usually established between a customer and an investment company, which pays the majority of the home’s purchase price. The customer pays a monthly rent to the investment company and makes regular investments in the partnership to increase his or her equity in the house. A Musharaka transaction is Shariah compliant because it uses the funds that both the customer and the bank have rather than just depending on the bank’s resources.

Murabaha: Another Islamic mortgage variation is a Murabaha  in which the investment company purchases a home and sells it to the buyer at an increased cost to cover expenses incurred during the sale. The Murabaha finance vehicle is like an installment sale in which the buyer pays for the item over time in agreed-upon installments. Because the buyer is aware of this markup, the transaction is governed by an “honest declaration of cost” and thus it follows proper Islamic economic principles.