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Introduction

To understand Islamic Banking necessitates understanding its roots. This is so because any

Paradigm is always constructed on preceding foundations. If the foundations are strong the

institution is strong also. The whole picture of Islamic banking cannot be visualised until its

foundations are not explored historically. Once the history is contextualised a brighter picture

emerges of the whole notion of Islamic Banking.

Most writers restrict the history of this banking sector to post-1963 era. They rarely venture

out to the pre- sixty-three era. Thus, a vague picture emerges from their writing about the whole

Islamic Banking saga.

Therefore, this work attempts to explore the roots of Islamic Banking from the onset of the

Islamic history and transverse the time till the present Credit Crunch period and beyond. It will also

explore financial engineering and learn lessons. It avoids discussing the institutional structure of

the Islamic financial industry due to fear of prolongation which will result in loss of focus and

defeat of goals of this paper. Thus the work intends to arrive at a sound conclusion by focusing on

afore-mentioned aims and objectives.

Islamic Banking: The Past

Islam, unlike other faiths, always promoted economic activity. Since many migrants to the

new city of Madīnah lost their wealth due to migration, for their economic alleviation, the Prophet

started a new initiative. This project was termed as Ikhā (to make brothers) or Muwākhāt (Mutual

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Brotherhood). Al-Mubārakpurī describes this Prophetic initiative as ‘unique in the history of the

world’.1 This was so because of the ‘magnetic personality of the Holy Prophet’ as Abdullah Yusuf

Ali reasons.2 This move could never have been conceived before Islam. To increase economic

incentive, this brotherhood also encompassed inheritance of wealth.3 However, this was a

temporary provision until the Qur'ānic Law of Inheritance was revealed which entrusted the rights

of inheriting to the demise’s relatives.4 Abdur Rahmān ibn ‘Auf, a Makkan who migrated to

Madīnah can be cited as a good example of this. Anas reports that the Prophet established

brotherhood between Ibn ‘Auf and Sa’d. Sa’d who was married to two wives, was ready to forsake

one by divorce and offer her to his ‘ new brother’ in marriage. But the ‘brother’ blessed his offer

and asked him to guide him to the market instead.5 The economic activity can be further evidenced

from above, where Abdur Rahmān ibn ‘Auf refuses his brother's economic welfare offer and asks to

be guided to the market. A closer read of Abū Bakr's words reveal further that the Makkans were

entrepreneurs. Al-Dimashki and H. Ritter (1917) quote his words, “If there were trade in Paradise, I

would choose cloth-trade because Abū Bakr al-Siddīq was a fabric-merchant”.6

Looking at the scale of economic activity that the above elucidates, it would be absurd to

suggest that there did not exist any financial intermediation or banking activity. Mohamed

Abdelhamid (2005, p.5) admits the fact of existence of such type of intermediation, stating,

“although modern Islamic banking is considered to be a recent development, Muslims were able to

access financial systems operating without interest since the beginning of Islamic history”.7 One

cannot ignore what Björklund et. al. (2004, p.17) stated, “Although banks did not exist, innovative

financial instruments were a part of commercial life. A frequently used expression is that they were

'bankers without banks'.”8

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These institutionalised Muslim 'bankers without banks', would engage in different financial

intermediary activities. Labib, while exploring the topic, expounded that, “savings or checking

accounts were not new to the Islamic world, and pawning, loaning, trusts, money changing, transfer

of credit, and transfer of debts were all important divisions of business life in any large Islamic city.

Yet neither the government nor the busi-nessmen took upon themselves the task of founding a state

bank which would take care of business transactions well and efficiently”.9 One would not find it

strange, to envisage these businessmen creating small entities with sole intention of providing

banking solutions. Whilst investigating year 320/926, Adam Mez braves by calling these entities as

banks because of their provision of banking services, reassuring that, “There was therefore plenty of

employment for bankers, and it is not surprising that in Isfahān there were 200 banks in the

Bankers' Bazaar-for these too sat together”.10

Thus, it would be unsurprising envisaging some early attempts towards an even larger

institutionalised bank. This can be assumed through carefully investigating the economic boom

enjoined by the Muslim lands. Such boom would surely give rise to creativity and development in

the early 'banking' industry. Two types of innovative banking institutes are recorded as signs of

such attempts. One of which, as noted by Labib, was Mawḍiʿ al-Hukm, into which the State used

to deposit its funds for certain specific purposes. The second of which, again scribed by the same

writer, and referred to by other earlier writers such as Amari, Dozy, Canale, and Quatremere was the

Maʿūnah, literally meaning help and support, a kind of private bank which loaned out state capital.11

These financial institutions enjoyed transformations and additions, too. Fischel (1937)

mentions that from 928, a special Diwān al-Jahābidhah was instituted, henceforth, many people

are recorded to bear this title.12 This institution was further developed as pointed out by Ray (1988?)

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and a specialised institution of 'Jahābidhah al-Haḍrah' or court bankers was created.13 Such status

was not restricted to Muslim bankers only, but Jewish bankers too enjoyed the same privilege. He

gives example of of two Jewish bankers, Joseph b. Phineas and Aaron b. Amram who were

regarded as court bankers who mainly carried three banking functions: Administration and

management of deposits, transfer of funds and advance of funds to Government in form of loans.14

This may be attributed to the pluralistic attitude of Muslims and their rulers as confirmed by

Bernard Lewis who notes that 'the Arab Muslim rulers of the new empire did not repeat the errors of

their predecessors but instead respected the pattern of pluralism that had existed since antiquity'.15

Conclusively, the above points out that the Muslims from the onset, engaged in trade

arduously. It also proves the existence of 'bankers without banks' as in the modern sense as it also

elucidates their role as financial intermediaries as pointed out by Labib. There seems to be a

process of development and institutionalisation of these small entities as the time progresses, as

highlighted by Adam Mez who informs his reader of existence of two hundred banks at Isfahān in

the 'Bankers' Bazaar'. The creativity and development in early Islamic banking industry contributed

to the creation of even larger specialised financial institutes, in different forms such as Maʿūnah and

Mawḍiʿ al-Hukm as evidenced above. The formation of Diwān al-Jahābidhah is also recorded

with creative addition of a specialised institution of 'Jahābidhah al-Haḍrah' or court bankers, all

preforming different financial intermediary functions. The question remains as to why

contemporary writers on the history of Islamic banking miss these facts or limit their mention to

'Bankers without Banks'. Th answer is simple. Either they do not want to dwell into the subject

and loose focus on the main highlight of modern Islamic banking or it may be lack of research on

the topic. Nonetheless, this writing clears the air and clarifies the existence of different types of

banks in the Medieval Islamic history. It also paves the way for further research into the subject.

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Post Colonial Modern Banking

As Professor Rodney Wilson clarifies that although Muslim-owned banks were established in

the 1920s and 1930s, such as Bank Misr of Egypt and the Arab Bank of Palestine, these institutions

adopted the same practices as their 'European-owned competitors' and interest based dealings

prevailed.16 Thus, the Ribā-based institutionalised banking system entered into the Muslim system.

Since financial intermediation should never be based economically on self-interest, rather it has to

take altruism on board, therefore, Ribā was abhorred both religiously and by reason. The Revealed

texts all mentioned its negation until Calvin gave 'fatwā' for the acceptance of 'commercial' Ribā.

There is no doubt whatsoever that this was based on self-interest rather that religious injunction that

calls for mercy and altruism. Slowly, Ribā took root in the West and gradually it was introduced in

the East during the period of colonisation. However, faithful Muslims did not accept it. For this

reason, they would rather live a life of poverty than accept such a system which was envisaged as

corrupt. They remained constant in helping each other monetarily on social level. Thus, one finds

both recorded and unrecorded projects of such kind. Mit Ghamr is widely seen as an attempt to

create such an institution to cater for a larger village community. The government politics took a

different turn. Monzer Kahf (2001: 2) observes, “the reason behind closure of Mit Ghamr which

operated between 1963 and 1967 was secularist government politics that branded the founders of

such experience as 'people's enemies'”.17

On academic level too, the post-colonial era inquired about financial intermediation without

Ribā. The first known attempt is that of Quraishi in 1948 in his published work, 'Islam and the

Theory of Interest'. We find from then, a wave of Islamic bankers and scholars dealing with the

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problem and trying their banking system to get rid of this western legacy of interest-based financial

intermediation. The aim of these writings, as Kahf observes, was to prepare Muslim Masses “to

crave for Islamic Banks” (2001: 3).18

Modern Islamic Banking

Mit Ghamr was not the demise of this dream. It was a start. Munawwar Iqbal et. al. observe

that the first interest-free institution with 'bank' in its name, Nasser Social Bank, was also

established in Egypt in 1971. This was the first time that a government in a Muslim country had

shown an interest in incorporating an interest-free institution.19

This idea attracted the attention of businessmen who had surplus funds. Thus four years later,

in 1975, Dubai Islamic Bank was established and operational, in Dubai, UAE. Although being a

private initiative, the governments of UAE as well as Kuwait inserted their share totalling 30%.

However, the most important development in Islamic Banking is the setting up of the IDB (Islamic

Development Bank) again in 1975. The ground work to this project was established in December

1973, by a conference of Islamic Ministers in Jeddah, followed by a second conference of Finance

Ministers in August 1974. Board of Governors met in July 1975 and by October 1975, the IDB

started its function.

1975 to 1990 is seen as the most important period in the history for the Modern Islamic

banking industry. During this period, the industry matured and was seen as the viable alternative to

the conventional method of financial intermediation. It won respect in terms of theoretical and

financial intermediation. Sharīʿah compatible products were developed which were tested as

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efficient. With the development of several Islamic banks, the idea attracted the attention of

countries such as Iran, Pakistan as Sudan which showed their willingness for implementation. IMF

and World Bank recognised Islamic banking products as the genuine tools of financial

intermediation. Though, the growth slowed down in 1990, non Bank Islamic financial institutions

came into existence such as the insurance and Islamic investment funds.

Financial Engineering & Current Global Financial Crisis

According to Iqbal et. al. (2005) the main obstacle to fast development of innovative financial

products were the Sharīʿah boards. Thus, they call for an autonomous Sharīʿah board. Sharīʿah

boards though being the obstacle, they saved the Islamic banks from the nightmare of falling into

the current Global Financial crisis on the basis of the principles that they abide to such as Gharar,

Maysir, and so on, thus preventing Islamic Banks from engaging in speculative instruments.

Financial engineers may have seen this as an obstacle but they may have realised that the

importance of localised Sharīʿah boards. As for autonomous Sharīʿah boards, the idea does not

sound so well for the simple reason that it could result in clash with the Islamic Banks' own

Sharīʿah boards. However, most importantly, Global ḥisbah is needed to monitor the activities of

the Sharīʿah boards to check whether their certifications fulfil the Sharʿī criteria or not. This can

ensure efficiency in their operations.

The Future - Conclusion

The future of Islamic banking industry will depend on which way it wants to move on. The

current crisis was an eye opener for both the Sharīʿah Scholars as well as Islamic Financial

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engineers. It will be wise to promote and expand the industry. This also reflects the view of Iqbal

et. al. Some actions are necessary for future growth such as diversifying the surplus.

Diversification is a good solution, for example, investing in Ṣukūk, in efficient and creative micro-

and macro-financing initiatives and so on. In doing so, information symmetry must not be

undermined as well as compliance to the Sharīʿah. Also, creativity in financial engineering,

governed by the Sharīʿah-backed 'noble' principles and regulatory framework, should be

encouraged. As for any future stagnation in growth, Sharīʿah boards should not be blamed and

taken as escape goats, however, in my view, two further actions should help in such circumstances.

First, creation of a global association of Sharīʿah boards that trains the Sharīʿah scholars, to

advance them in the understanding of newly engineered products and their Sharʿī constructs.

Second, promotion and managed expansion of Islamic Banking industry. As for the promotion of

the industry, this can only be actualised through advertisement, awareness, road shows, speeches,

programmes and so on. Altruism must also play a great role in the Islamic banking industry, an

elixir in the Islamic economics and one of the reasons for the birth of Islamic banking paradigm.

Thus the institution of Zakāh, Ṣadaqah, Qarḍ Ḥasan, classical Muḍārabah, micro-financing

initiatives, extension of help to Muslim charities and the likes must be incorporated in it, which

ultimately will act as life blood to the industry. In summary, diversification, Sharīʿah-backed

creativity in financial engineering, expansion, promotion, training through creation of global

association of Sharīʿah boards and insertion of above-stated Altruistic instruments can provide

stimulant future direction for Islamic banking industry. Additionally, research and investigation

into the application of Global ḥisbah in Islamic banking can also play a great synergy-inducing role

in its future strategy.

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Bibliography
Abdelhamid, Mohamed. (2005). Islamic Banking. Dept. of Economics. Carleton University, Otawwa, Ontario.

Ali, Abdullah Yusuf, The Meaning of the Holy Qur’an, (Maryland: Amana Corporation, 1992)

Al-Dimashki/H. Ritter, "Ein arabisches Handbuch der Handelswissenschaft," Der Islam, 17, 1917.

Al-Mubārakpurī, Safi-ur-Rahman. Ar-Raheeq Al-Makhtūm. The Sealed Nectar: Biography of the Noble Prophet, (Riyadh:

Maktabah Dar-us-Salam, 1995).

Ahmad, Imām, al-Bidāyah.

Ali, Abdullah Yusuf, The Meaning of the Holy Qur’an, (Maryland: Amana Corporation, 1992).

Björklund, Iréne and Lisbeth Lundström (2004). Islamic Banking: An Alternative System. Kristianstad University.

Fischel, W. J. (1937). Jews in Economic and Political Life of Medieval Islam.

Hajar, al-Hāfīz Ibn, Fath al-Bārī.

Kahf, M. (2001). Islamic Banks: The Rise of a New Power Alliance of Wealth and Shari'ah Scholarship.

Kandhlāwī, Muhammad Yusuf (1981), The Lives of the Sahabah, (New Dehli: Globe Offset Press).

Labib, Subhi Y. (1969). Capitalism in Medieval Islam. The Journal of Economic History, Vol. 29, No. 1, The Tasks of

Economic History, pp. 88-9. http://www.jstor.org/stable/2115499. [Accessed: 04/06/2008 16:54].

Lewis, Bernard, The Jews of Islam, (London: Routledge & Kegan Paul, 1984)

Ray, Nicholas Dylan. The Medieval Islamic System of Credit and Banking: Legal and Historic Considerations. In Arab Law

Quaterly, 1988?

Wilson, Professor Rodney (n.a.,:1). The evolution of Islamic Financial System.

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1
Al-Mubārakpurī, Safi-ur-Rahman. Ar-Raheeq Al-Makhtūm. The Sealed Nectar: Biography of the Noble Prophet,
(Riyadh: Maktabah Dar-us-Salam, 1995), p. 188.
2
See Ali, Abdullah Yusuf, The Meaning of the Holy Qur’an, (Maryland: Amana Corporation, 1992), p.433, n.1239.
3
Hajar, al-Hāfīz Ibn, Fath al-Bārī, p.191, vol. VII. Also see Kandhlāwī, Muhammad Yusuf (1981), The Lives of the
Sahabah, (New Dehli: Globe Offset Press), p.480, vol. I.
4
See Ali, Abdullah Yusuf, The Meaning of the Holy Qur’an, (Maryland: Amana Corporation, 1992), p. 434. n.1245.
5
Ahmad, Imām, al-Bidāyah, p. 228, vol. III.
6
Al-Dimashki/H. Ritter, "Ein arabisches Handbuch der Handelswissenschaft," Der Islam, 17, 1917.
7
Abdelhamid, Mohamed. (2005). Banking. Dept. of Economics. Carleton University, Otawwa, Ontario. p.5.
8
Björklund, Iréne and Lisbeth Lundström (2004). Islamic Banking: An Alternative System. Kristianstad University.
(History of Islamic Banking 4). p.17.
9
Labib, Subhi Y. (1969). Capitalism in Medieval Islam. The Journal of Economic History, Vol. 29, No. 1, The Tasks of
Economic History, pp. 88-9. http://www.jstor.org/stable/2115499. [Accessed: 04/06/2008 16:54].
10
Ibid, p.89.
11
Ibid, p.89.
12
Islamic See Fischel, W. J. (1937). Jews in Economic and Political Life of Medieval Islam, London. n.1, p.5.
13
See Ray, Nicholas Dylan. The Medieval Islamic System of Credit and Banking: Legal and Historic Considerations.
In Arab Law Quaterly, 1988? p.69.
14
Although Ray mentions that the funds were advanced on interest but he admits on two quoted incidents that it was
unclear that interest was charge on them. Please refer to p.70 of his already mentioned work.
15
Lewis, Bernard, The Jews of Islam, (London: Routledge & Kegan Paul, 1984), p. 19.
16
Wilson, Professor Rodney (n.a.,:1). The evolution of Islamic Financial System. p.1
17
Kahf, M. (2001). Islamic Banks: The Rise of a New Power Alliance of Wealth and Shari'ah Scholarship. p.2.
18
Ibid., p.3.
19
Iqbal, M. and Philip Molyneux (2005). Thirty Years of Islamic Banking: History, Performance and
Prospects.