Islami Banking

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                                 Islami Banking

Islami Banking a new type of banking that operates on principles adhering to the
Quranic norms forbidding usury and transactions, including granting of loans or credits
for interest. The economic rationale for eliminating riba (interest) and establishing the
Islamic BANKING SYSTEM is based on values of justice, efficiency, stability and growth. It
is assumed that under the system of Islamic banking, the industrial and/or commercial
risk is shared more equitably between the entrepreneur and the capital owner and the
returns on investment are shared among the investors on the basis of their proportionate
capital. The conventional banks tend to serve the most creditworthy borrowers, while the
Islamic banking system presumably looks for the most productive and profitable projects.
The Islamic banking approach theoretically opposes the idea of discrimination in offering
banking services to people of different social standings and provides for social cohesion
between different classes.

The origins of Islamic banking can be traced back to the practice of mudaraba by the
Prophet Muhammad (Sm) himself. The Prophet (Sm) was mudarib (agent) for his wife,
who entrusted her capital or merchandise to him for trading and got back the principal
plus an agreed share of the profit. As a reward for his labour (and entrepreneurship), the
Prophet (mudarib) received his share of the same. The mudarib, however, was not liable
for losses resulting from the exigencies of travel or from an unsuccessful business
venture. This form of partnership is called mudaraba. There is another form of
partnership called musharaka, in which the musharik (agent) has a contribution to the
capital and can therefore, claim a higher percentage of profit. As early as in the seventh
century, the tax revenue from Iraq was sent across the desert to Medina in the form of a
mudaraba. Caliph Umar is known to have invested orphans' money in merchant trading
between Medina and Iraq. Musharaka partnerships were practised in the north-south trade
between Egypt and Jeddah during the eleventh century. As many as 32 mudaraba

contracts were practised in the 17th century in the Turkish city of Busra. Mudaraba was
in practice in Tunisia, Indonesia, Arabian Peninsula and India.

Modern Islamic banking concepts came from the historical practice of the concept of a
'three-tier mudaraba'. On the first tier, there is the individual, rab-al-mal, who wishes to
invest capital. The second tier is the mudarib (agent), to whom the rab al-mal entrusts his
capital by contract and finally, on the third tier, there is the entrepreneur, with whom the
mudarib signs a contract, and to whom the mudarib passes the capital originally entrusted
to him by the rab-al-mal.

The first attempt to establish an Islamic financial institution took place in Pakistan in late
1950s with the establishment of a local Islamic bank in a rural area. Borrowers of the
bank did not pay interest on the CREDIT advanced, but a small charge was levied to cover
the bank's operational expenses. Although the experience was encouraging, two main
factors were responsible for its failure. First, the deposits made in the bank were to be
held for long and the depositors, who were mostly the landlords found that with
increasing number of borrowers the gap between the amount of capital available and that
of the credit demanded had become very large. Secondly, the depositors showed
considerable interest in the way their money was lent out but the bank staff did not have
complete autonomy over the bank's operations and therefore, could not always satisfy the
customers in this regard.

The second experiment with Islamic banking was conducted in Egypt between 1963 and
1967 through the establishment of the Mit Ghamr Savings Bank in a rural area of the Nile
Delta. The bank's operations were based on the same Islamic principles of no-interest to
depositors or from the borrowers. Unlike the Pakistani case, the borrowers made deposits
in the bank for credit facilities. On the basis of success in the experiment more branches
were soon opened in different parts of Egypt to develop a network of local savings banks.
The project suffered a setback due to political unrests in the country but was revived in

1971 under the name of Nasser Social Bank, which became the first Islamic bank in the
urban setting based in Cairo.

Following the example of Egypt, Islamic banking emerged in Malaysia in 1963 and in
Dubai in 1975. A significant development in Islamic banking was the granting of a
license to Islamic bank in Saudi Arabia. This bank was established by the fifty-year old
Al-Rajhi Company, a firm with assets valuing more than $5 billion and noted for its
currency, exchange and commercial activities. The bank started operations in 1985 under
the name of Al-Rajhi Banking Investment Corporation and later, developed active
relationships with major manufacturing and trading companies in Europe and several US
corporations. The success of Al-Rajhi in operating profitably in different regions of the
world motivated the Saudi government to go for full-fledged Islamic banking. In 1975,
the Muslim countries have founded Islamic Development Bank as a multinational
corporation to support social and economic development in Muslim nations within an
Islamic Framework. Bangladesh is a member of the Islamic Development Bank.

Islamic banking started in Bangladesh through establishment of the ISLAMI BANK
BANGLADESH     Ltd. (IBBL), which is considered to be the first interest-free bank in
Southeast Asia. It was incorporated on 13 March 1983 as a public limited company under
the COMPANIES ACT 1913. In December 2001, IBBL had 121 branches, its authorised
capital was Tk 1000 million and paid up capital Tk 640 million. AL BARAKA BANK Ltd,
often called the second Islamic bank of Bangladesh, commenced banking business on 20
May 1997. It is a joint-venture enterprise of Al-Baraka Investment and Development
Company, a renowned financial and business house of Saudi Arabia, Islamic
Development Bank, a group of eminent industrialists of Bangladesh, and the government
of Bangladesh. The authorised capital of the bank is Tk 600 million and its paid up
capital is Tk 259.55 million. The bank has now 35 branches in different parts of the

In addition to extending conventional commercial banking facilities to its customers, the
bank gives substantial financial support to the implementation of industrial and real estate
projects. In 1996, two more Islamic banks were given clearance to operate under Islamic
banking principles. They were the AL-ARAFAH ISLAMI BANK Ltd. and SOCIAL
INVESTMENT BANK.     The fifth Islamic bank of the country is a foreign bank named the
SHAMIL BANK OF BAHRAIN,     which was created through merger of the Faisal Islamic Bank
of Bahrain and an Islamic Finance Company.

Collection from The Banglapedia.
Abdur Rab (forhad)
Department of Public Administration.
Jahangirnagar University
Dhaka, Bangladesh.

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