Thus, Islamic banking emerged as a response to both religious and economic exigencies. While religious exigency calls for avoiding any transaction based on interest, economic exigencies, on the other hand, provide a new outlook to the role of banking in promoting investment productive activities, influencing distribution of income and adding stability to the economy. Islamic banking is thus perceived as an improved system in all dimensions.
The first attempt
Interestingly, the concept of Islamic Banking is several decades old. The first attempt to establish an Islamic financial institution took place in Pakistan in the late 1950s with the establishment of a local Islamic bank in a rural area (Wilson 1983). Some pious landlords who deposited funds at no interest, and then loaned to small landowners for agricultural development initiated the experiment. The borrower did not pay interest on the credit advanced, but a small charge was levied to cover the bank’s operational expenses. The charge was far lower than the rate of interest. Although the experience was encouraging, two main factors were responsible for its failure. First, the depositors’ landlords regarded the deposits as a one-time event. With the increasing number of borrowers the gap between available capital and credit demanded was huge. Secondly, the bank staff did not have complete autonomy over its operation; depositors showed considerable interest in the way their money was lent out (Ibid).
The second attempt
The second pioneering experiment of putting the principles of Islamic banking and finance into practice was conducted in Egypt from 1963 to 1967 through the establishment of the Mitt Gamer Savings Bank in a rural area of the Nile Delta. The experiment combined the idea of German savings banks with the principles of rural banking within the general framework of Islamic values (Ahmed 1992). The bank’s operation was based on the same Islamic principle i.e. no-interest to the depositors or from the borrowers. Unlike the Pakistani bank, the borrower had to have deposits in the bank in order to request a loan. The experiment soon became successful; more branches were opened in different parts of the country, and the amount of deposits increased. Hence, what started as a single bank operation expanded to form a network of local savings banks? Although the project made a good start and initial results were more than encouraging, it suffered a setback owing to changes in the political atmosphere.
Nevertheless, the project was revived in 1971 under the name of Nasser Social Bank. This was the first Islamic bank in an urban setting based in Cairo. The bank is a public authority with an autonomous status. Its purpose was mainly to promote social concerns such as granting of interest-free loans for small projects on a profit-loss-sharing basis, and assistance to the poor and needy students for university and higher education. Because of these social functions, Nasser Social Bank was granted an exemption from the Banking and Credit Law of 1957 in its initial stages. The bank was originated under the Ministry of Treasury but it is now functioning under the Ministry of Social Welfare and Insurance. Its capital comes from the funds allocated by the President from extra budgetary resources, appropriation from the state budget, and contribution from the Ministry of Awqaf (Ahmed 1992). The principles of operation of the Naser Social Bank are very similar to those of the Mitt Gamer Savings Bank. However, the latter offers a full range of normal banking services and a wide range of investment activities through equity participation (Asker 1987, pp.18-35)
Tabung Hajji: a successful attempt
Islamic banking, with a very different approach contemporary to that in Egypt, emerged in Malaysia. It was a financial institution developed for the pilgrims of Malaysia. These institutions were established in response to what was the contention of the Malaysian Muslims that money spent on pilgrimage must be clean and untainted with ‘Riba’. Since this was not possible by depositing money with the ordinary banks, a special financial institution had to be created. Consequently, Pilgrims Saving Corporation was established in 1963, which was later on incorporated into the Pilgrims Management Fund Board (Tabung Hajji) in 1969 (A. Ahmad 1993)
Next to follow was the Dubai Islamic Bank in 1975. The Dubai Islamic Bank is a public limited company having its office at Dubai, U.A.E with capital of 50 million Dirhams. Since then, a number Islamic banks and financial institutions have been established in different parts of the world and have been functioning successfully.
A significant development in Islamic banking has been the granting of an Islamic bank license in Saudi Arabia to the fifty-year old “Al-Rajhi Company”, a firm noted for its currency, exchange and commercial activities, whose assets exceed $5 billion. The firm started operation in 1985 under the name of “Al-Rajhi Banking Investment Corporation” and has since developed active relationships with major manufacturing and trading companies in Europe and several U.S. corporations. The emerging success of Al-Rajhi in operating profitably in different regions of the world has increased pressure on the Saudi government to go for full-fledged Islamic banking (Mangla,Uppal&Swamy1988,p.54).
An example of multi-cooperation at the government level in the field of Islamic banking is the Islamic Development Bank, which was founded in 1975 as a multi-national corporation by several Muslim countries. The purpose of the bank is to support social and economic development in Muslim nations within an Islamic Framework. The subscribers of the capital are the founder governments and, as such, it was established by government treaty.
In addition, an Islamic bank/investment company was established in Bahamas in 1977 as a multi-national holding company under the name of Islamic Investment Company, ICC limited. Its purpose was to establish ‘Mudaraba’ (partnership companies) in various parts of Islamic countries. The company has established two ‘Mudaraba’ subsidiaries in Sharjah and Pakistan.
A second example of Islamic banking in the West comes from Luxembourg, where the Islamic Banking System International Holding was established in 1978 as a joint-stock company. Its purpose was to establish international Islamic banks in different parts of the western countries where there are communities of Muslims, and to participate in investment projects in Islamic and non-Islamic countries. The company’s investment operations are spread over different parts of the world. As a holding company, it established a new affiliated company in London in June 1983 under the name of Islamic Finance House, and another in Denmark in 1982 under the name of the Islamic Bank International of Denmark. Dar-al-mal-al-Islami (DMI), based in Geneva, was established in 1981. DMI aims to foster an Islamic financial system based on equity and social justice by incorporating three types of institutions – banking, investment and insurance. Thus, DMI may be considered as a major multi-national company, the activities of which consist of Islamic investments, Islamic solidarity (insurance) and Islamic banking operations (Ashker 1987, pp.18-35). DMI group has adopted a high profile and ambitious campaign to open an Islamic bank and investment in over thirty countries.
The second major group is the Kuwait Finance House (KFH). It was established in 1978. The Kuwait government and the remainder by private Kuwait investors own Forty-nine percent of the KFH. Total value assets of KFH at the end of 1987 were $3.92 billion with a deposit of $3.62 billion. The source of KFH’s liquidity is cheap deposits from faithful Muslims. The group has concentrated on large scale project financing, particularly in real estate. The KFH does have a minimum account size and, therefore, it could be argued that the institution only caters to the richer member soot The society. Another dynamic Islamic banking conglomerate is the ‘Al-Baraka’ group, which operates banks, investment companies, and financial advisory and management companies in more than a dozen countries. It launched its activities only in 1982, but the group now has a total asset of over $2.7 billion. It is considered to be one of the fastest growing Islamic enterprises. The group has operations in Tunisia, Sudan, Bahrain, Turkey, and Malaysia. It is the first group to obtain a license to launch Islamic banking in London.
Complete Islamization Efforts
A development of complete Islamization of banking at national levels had been gaining momentum since the second half of the 1970s. The movement took basically two forms. First, an attempt was made to establish Islamic financial institutions side-by-side with traditional
Banking. In such attempts, two types of institutions were evolved: Islamic banks were established mostly in Muslim countries; and Islamic investment and holding companies started operating in some Muslim but mostly in non-Muslim countries. These institutions claimed to be operating without interest in their transactions and competed with conventional banks to attract deposits. The majority of these institutions were established through private initiatives. Second, an attempt was made to restructure the whole financial system of the economy in accordance with the teachings of Islam. This second approach was accomplished in two distinct ways, as exemplified by the changes in Iran and Pakistan. Complete Islamization efforts of some leading countries are now discussed.
The process of Islamization of Islamic banking in Iran has proceeded in three distinct phases. Nationalization, restructuring, and reorganization of the entire banking system characterized phase one taking place between 1979 and 1982. External and internal developments did not allow the policy makers to develop a coherent plan for Islamization of the banking system, although various piecemeal attempts were made towards this objective (Khan & Mirakhor 1989).
The second phase began in 1982 and lasted until 1986. It was a phase primarily characterized by adoption of legislative and administrative steps in order to implement a clearly articulated model of Islamic banking (Iqbal & Mirakhor 1987, p.106). The law for Riba-free banking was passed in August 1983, giving a very short deadline of one year to the banks to convert their deposits in line with Islamic law and their total operations within three years from the date of the passage of the law. The third phase, which continues till now, began in 1986. This phase defines the role of the Islamic banking system differently from the earlier phases. The system is now expected to be an integral part of the Islamic government, and thus, a direct instrument of its policies.
This development is a direct result of the political debate within Iran surrounding the proper role of the government in an Islamic economy. This debate culminated in a ruling by Imam Khomini, which confirmed a highly activist role for the central government in shaping the structure of the Iranian economy and legitimized a trend in the interventionist posture of the government vis-à-vis the economy. The ruling also indirectly affirmed the use of the banking system as an instrument for promoting social and economic development. The banking sector has been used as an instrument to restructure the Iranian economy. The restructuring was essentially directed towards the shifting of financial resources from services and consumption to the production sector in four ways. First, credit to the service sector, which constituted some 55 percent of the GDP (1984-85), has been drastically reduced to halt its expansion in the short-run and curtail its size in the mid-term. Second, using all available modes of Islamic finance to help farmers to improve and expand production has used bank credit to encourage the growth of the agricultural sector. Coupled with substantial government subsidies for seed, fertilizer, machinery, and crop insurance, the credit policy of the banking system is aimed at reviving the agricultural sector. Third, Islamic banking has been used to create incentives for the development of a co-operative sector spanning agriculture, industry, and trade. Fourth, the banking system, in partnership with the government, undertakes to finance large industrial projects and investment in social overhead capital (Mirakhor & Zaidi 1988, p.3).
Pakistan adopted a policy of gradual transformation of its banking system from February 1979 after several years of study and preparation by the government-appointed Council of Islamic Ideology (CII). The process started when the President of Pakistan announced that interest was to be removed from the economy within a period of three years. Three of the specialized credit institutions–the House Building Corporation, National Investment Trust, and Mutual Trust Funds of Investment Corporation of Pakistan–were to remove interest from their financing operations immediately.
Following the directive issued by the government in January 1981, separate counters were opened in the commercial banks for accepting deposits on a PLS basis. Commercial banks were instructed to create separate accounts for deposits in their interest-based operation and those received on the PLS basis.
A series of directives were issued in 1981 by the State Bank of Pakistan permitting commercial banks to issue non-interest based credit to finance exports and imports of commodities, and to provide financing for trading operations and housing. In June 1984, the government announced discontinuation of dual window operations of the banking system within one year. As a result, all financial operations of the banking and financial system, except the foreign currency deposits which continue to earn fixed interest, were brought under the non-interest based mode so financing. However, along with the change of regime the progress of Islamic banking has been constrained by lack of operating Islamic ethical norms in the business environment. The posture of the policy makers toward Islamic banking in Pakistan has been marked by a great deal of caution. The banking community has shown a reluctance to engage in medium- or long-term industrial financing on a profit-sharing basis. Islamic banking in Pakistan appears to be at a crossroads, and if there is to be further progress the regulatory and legal conditions must be such that the system will have a fair chance to perform as expected.
In August 1974, Bangladesh signed the Charter of Islamic Development Bank and committed itself to reorganize its economic and financial system as per Islamic Shariah. In January 1981, Late President Ziaur Rahman while addressing the 3rd Islamic Summit Conference held at Makkah and Taif suggested, ”The Islamic countries should develop a separate banking system of their own in order to facilitate their trade and commerce.” This statement of Late President Ziaur Rahman indicated favorable attitude of the Government of the People’s Republic of Bangladesh towards establishing Islamic banks and financial institutions in the country. Earlier in November 1980, Bangladesh Bank, the country’s Central Bank, sent a representative to study the working of several Islamic banks abroad. In November 1982, a delegation of IDB visited Bangladesh and showed keen interest to participate in establishing a joint venture Islamic bank in the private sector. They found a lot of work had already been done and Islamic banking was in a ready form for immediate Introduction. Two professional bodies -Islamic Economics Research Bureau (IERB) and Bangladesh Islamic Bankers’ Association (BIBA) made significant contributions towards introduction of Islamic.
Banking in the country. They came forward to provide training on Islamic banking to top bankers and economists to fill-up the vacuum of leadership for the future Islamic banks in Bangladesh. They also held seminars, symposia and workshops on Islamic economics and banking throughout the country to mobilize public opinion in favor of Islamic banking.
Their professional activities were reinforced by a number of Muslim entrepreneurs working under the aegis of the then Muslim Businessmen Society (now reorganized as Industrialist & Businessmen Association). The body concentrated mainly in mobilizing equity capital for the emerging Islamic bank. At last, the long drawn struggle to establish an Islamic bank in Bangladesh became a reality and Islami Bank Bangladesh Limited was established in March
1983 in which 19 Bangladeshi national, 4 Bangladeshi institutions and 11 banks, financial institutions and government bodies of the Middle East and Europe Including IDB and two eminent personalities of the Kingdom of Saudi Arabia joined hands to make the dream a reality. Later, other three Islamic Banks were established in the country.
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