Overview of The History of Islamic Banking

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About this sample


Words: 1833 |

Pages: 4|

10 min read

Published: Oct 11, 2018

Words: 1833|Pages: 4|10 min read

Published: Oct 11, 2018

Table of contents

  1. Introduction
  2. Islamic Banking
  3. Model of Islamic Banking
  4. Mudarabah
  5. Commercial Banks In Muslim Lands
  6. Islamic Banks In 20th Century


Islamic banking business is banking activities based on Islamic or Shariah. It follows Islamic Rules on transactions. Islamic Banking is based on Islamic law also referred as Shariah law and guided by the Islamic economies. Islamic Banking is founded on two key factors-Religion and Profit . The organization must internalize the teachings of Islam. It will involve moral elements by the virtue of the factor of Imaan.(Faith and Believe). in the business operations. If the moral factors alone is given importance, there is possibility that the bank would experience losses and forced to ceased operations, so Islamic Banks also give dimensions to the business and also importance. Shariah prohibits Riba. Investment in business that provide goods or services contrary to Islamic principles is Haram. This prohibition is applied in many Muslim countries to prevent Un-Islamic Banking system. By applying these Islamic principles we can avoid Allah's anger. Bank should strictly follow Shariah and uplift the living standards of those who try to do so in Islamic way.

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The concept of Islamic free banking is becoming widely popular in the non Islamic countries too. The interest free bank work with the rule that the lender must have a share from the profits or the losses. The lender and the borrower are like partners and that plays a major role in characterizing the social order.

The Islamic banking was introduced in july,1979 in the banking and financial system of Pakistan. The government of Pakistan decided that only Islamic system can ensure better standard of life. To make easy the introduction of interest free banking some necessary rules were made in the banking laws in June 1980 in Pakistan. Different companies start the business on the basis of interest free system.

Islamic Banking

In Late 20th Century number of Islamic banks formed to apply the Islamic principles. There number and size has grown so that by 2009, there were over 300 banks and 250 Mutual funds around world based on Islamic laws and around $to trillion were there in 2014.

Islamic law is derived from the following four sources.

  1. The Holy Quran
  2. The Sunnah of Holy Prophet (P.B.U.H)
  3. Ijma
  4. Qiyas The Holy Quran

Quran is one of the primary source of Islamic law. It includes many commandments, rules and principles for the behavior and relations of individuals in the society. Most of its principles are general in nature through some of them are well defined. The words of Quran are final and no one can change its text. The Sunnah Equally important the Sunnah the secondary source of Islamic law. The Sunnah are path or way of Prophet Muhammad (P.B.U.H). The Sunnah consists of the sayings, deeds and words ,action or even silence of Prophet Muhammad (P.B.U.H). ‘‘Take whatever the messenger gives you, and refrain from whatever he forbids you" (Al-Hashr)

In order to understand the teaching of Quran, the understanding of Quran ,the understanding of Sunnah is Compulsory. Ijma Ijma means the agreement of mujtihad of Ummah on an issue requiring the exercise of ijtihad. For Example: The institution of khilafat is established on the basic of ijma among the Islamic jurists. Qiyas Qiyas is the process in which Mujtihad extends sharia where there is no such guidence from sharia (similarity of cases) Deep insight is needed For Example: From wine, the jurists concluded and generalized that all things causing unconsciousness are prohibited by Islam. Holy Prophet (P.B.U.H): "Every loan that drives benefit (to the lender) is Riba " Also in Quran (surah-Al-Bakarah) "o those who believe; fear Allah and give up what still remains riba if you are believers. But if you do not do so, then be warned from Allah's was and his Messenger. If you repent even now, you have the right of the return of you principal; neither will you do wrong nor will you be wronged."

Model of Islamic Banking


Mudarabah is a special kind of partnership where one partner providers the capital to the other (Mudarib) for investment in a commercial enterprise. According to Mufti Taqi Usmani a mudarabah arrangement differs from the musharakah in three major ways.

  • The investment in musharakah comes from all the partners while in mudarabah, investment is the sole responsibility of rabb-ul-maal.
  • In musharakah all the partners can participate in the managements of the business and can work for it, while the mudarabah the rabb-ul-maal has no right of participate in the management which is carried out by the mudaribonly.
  • In musharakah all the partners share the loss to the extent of the ratio of their investment while in mudarabah the loss ,if only suffered by the rabb-ul-maal only, because the mudarib does not invest anything


Musharakah is the type of Shirkat-ul-Amwal which literally means sharing.

In the context of business, It refers to a joint enterprise share profit and loss of enterprise. Musharakah has far reaching implications for Islamic Banking and finance in the modern context and provides an excellent alternative to the interest based economy. In a musharakah, the party investing the capital shares equally in both the profit and loss, which is different from an interest based system where the upside is limited while the downside is very nearly nonexistent. These are two references clearly show that the profit leading to Riba is haram and against shariah Islamic Banking Transactions are Riba-free transactions. It ensures mutual benefit, covering and spreading risks of both counter parties. Islamic Banks do not provide any assistance and strictly discourages the production of goods and services which are against the Islamic values. Islamic banks should ideally have their own bench mark system for determination of profit. Since the industries in its initial stage of development; it is using the available bench mark for the banking industry. It is expected that once it is grown to a sizeable level it would have its own bench mark. However, using interest rate bench mark for determining the profit of any permissible transactions does not render the transactions as invalid or harm. It is the nature or mechanism of the transactions that determines its validity.

Islamic banking has the same purpose as conventional banking expect that it operates in accordance with the rules of shariah known as Fiqh-al-Muamalat. Islamic Banking activities must be practiced consistent with the shariah and its practical application through the development of Islamic economics. Many of their principle upon which Islamic banking is based are commonly accepted all over the world, for countries rather than decades. These principles are not new but are arguably, their original state has been altered over the countries. The principle source of the shariah is the Quran followed by the recorded sayings and actions of prophet Muhammad (P.B.U.H), the hadith. Where solutions to problems cannot be found in the two source, Rulings are made based on the consensus of a community leaned scholars, independent reasoning of an Islamic scholar and custom, so long as such rulings to not deviate from the fundamental teachings in the Quran.

It is evident that Islamic finance was practiced pre-dominently in the muslim wend throughout, the middle ages, fostering trade and business activities. The Spain and the Mediterranean and Baltic states, Islamic Merchants become indispensable Middle-Men, for trading activities. It is claimed that many concept, techniques and instruments of Islamic finance were later adopted by European financiers and business man. The revival of Islamic banking coincided with the worldwide celebrations of the advent of the 15th Century of Islamic calendar (Hijra) in 1976. At the same time financial resources of Muslims particularly those of the end producing countries. Received a boost due to rationalization of the oil prices, which had hitherto been under the control of foreign oil cooperation. These events led Muslims to strive to model their lives in accordance with the ethics and principles of Islam.

Commercial Banks In Muslim Lands

Western commercial banks data from about two and a quarter countries ago, when the Western world was dispersing with moral and ethical consider actions in economics, when the Muslim world came into contact with west Muslims had two choice:

  1. To accept commercial banking ,arguing that the interest charged by them, did not contain the element of the Riba prohibited in the Quran
  2. To accept that interest charged was Riba and try to develop an alternative system of banking.

But ancient Muslim institutions, such as the Shariah courts had been made in effective by the power. Muslims had no alternative but to work with the coronial institutions, in duding commercial banking ;nevertheless, during the 19th century, several religions scholars argued that the term Riba refered to loans for consumption, which people found it difficult to repay, and not to commercial banking loans, where the debtor can repay from the profits. But the Quran makes no distinction between loans for consumption and loans for productive purposes, so their views wore rejected. As a consequence, Modern commercial banking did not make headway in muslim countries and to this day the presents and to conventional framework still dominates. The national financial system. The traditional functional reserve banking system was replaced with/by two separate financial restitutions:

  • Deposit banks, which would maintain 100% Reserves. They could not fail the depositors and could not create or destroy effective money. They would simply accept deepest.
  • investment trusts, which would perform the lending functions of existing banks such companies would obtain funds for lending by selling their own stock.

Islamic Banks In 20th Century

When in 1960s, Muslim thinking be gain to explore way and means of organizing commercial banking on an interest free basis, economists dismissed their work as the wishful thinking. But in 1963,in MIT GRAMY in Egypt, the first Islamic interest-free bank came into being. MT Gharm was a rural area and the people were religious. They did not place their savings in any bank, knowing that interest was far bidden in Islam. In these circumstances, the task was not only to respect Islamic value concerning interest, But also to educate people about the use of banking.

The following accounts were accepted:

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  •  saving accounts
  •  investment accounts
  •  zakat account

No interest was paid on savings accounts but with drawls could be made on demand. Small, short term, interest free loans for productive purposes could be made funds in investment accounts were subject to restricted with drawls and invested on the basis of profit sharing. The Zakat account attracted the official amount of Zakat. The Mit Gharm project was success full, as deposits increased form 1963 to 1966. The bank was cautions, rejected about 60% of loans application and the default ratio was Zero. In economically good times, But project was eventually abandoned for political reasons. Nevertheless, it had shown that commercial banking could be organized on a non-interest basis. Conclusion In and all, Islamic Banks hold the system which is based on Islamic laws and rules. It prohibits Riba and fellows the sayings of Allah and his Messenger Muhammad (P.B.U.H). Ratio of Islamic banks have increased and have reached to a major amount.

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Overview of the History of Islamic Banking. (2018, October 08). GradesFixer. Retrieved July 15, 2024, from
“Overview of the History of Islamic Banking.” GradesFixer, 08 Oct. 2018,
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