ASSIGNMENT QUESTION:

Write the history of Islamic banking in global

perspective and Pakistan.

OBJECTIVE:
The Islamic banking today has become most popular and reliable financial system
in the world. It appeared on the world scene as active player over three decades ago.
But as many of us know most of the principles which is based on Islamic Banking,
commonly accepted by the all over the world goes for centuries than the decades.
Islam as a religion very clearly prohibits the Riba -the interest, so the basic principle
of Islamic banking is the prohibition of Riba (Usury or Interest) base transactions.

The objectives of this assignment is to know about

1.The History of Islamic banking in global scenario.
2. What is the impact of Islamic banking system?
3. History of Islamic banking in Pakistan.
4. What is the current situation of Islamic baking in
Pakistan?
ISLAMIC BANKING
Islamic banking has been defined as banking in consonance with the ethos and value
system of Islam and governed, in addition to the conventional good governance and risk
management rules, by the principles laid down by Islamic Shariah. Interest free banking
is a narrow concept denoting a number of banking instruments or operations, which avoid
interest. Islamic banking, the more general term is expected not only to avoid interest-
based transactions, prohibited in the Islamic Shariah, but also to avoid unethical practices
and participate actively in achieving the goals and objectives of an Islamic economy.

Islamic Shariah prohibits ‘interest’ but it does not prohibit all gains on capital. It
is only the increase stipulated or sought over the principal of a loan or debt that is
prohibited. Islamic principles simply require that performance of capital should also be
considered while rewarding the capital. The prohibition of a risk free return and
permission of trading, as enshrined in the Verse 2:275 of the Holy Quran, makes the
financial activities in an Islamic set-up real asset-backed with ability to cause ‘value
addition’. Islamic banking system is based on risk-sharing, owning and handling of
physical goods, involvement in the process of trading, leasing and construction contracts
using various Islamic modes of finance. As such, Islamic banks deal with asset
management for the purpose of income generation. They will have to prudently handle
the unique risks involved in management of assets by adherence to best practices of
corporate governance. Once the banks have stable stream of Halal income, depositors
will also receive stable and Halal income. The forms of businesses allowed by Islam at
the time the Holy Quran was revealed included joint ventures based on sharing of risks &
profits and provision of services through trading, both cash and credit, and leasing
activities. In the Verse II:275, Allah the Almighty did not deny the apparent similarity
between trade profit in credit sale and Riba in loaning, but resolutely informed that Allah
has permitted trade and prohibited Riba.Profit has been recognized as ‘reward’ for (use
of) capital and Islam permits gainful deployment of surplus resources for enhancement of
their value. However, along with the entitlement of profit, the liability of risk of loss on
capital rests with the capital itself; no other factor can be made to bear the burden of the
risk of loss. Financial transactions, in order to be permissible, should be associated with
goods, services or benefits. At macro level, this feature of Islamic finance can be helpful
in creating better discipline in conduct of fiscal and monetary policies. Besides trading,
Islam allows leasing of assets and getting rentals against the usufruct taken by the lessee.
All such things/assets corpus of which is not consumed with their use can be leased out
against fixed rentals. The ownership in leased assets remains with the lessor who assumes
risks and gets rewards of his ownership.

HISTORY OF ISLAMIC BANKING

During the Islamic Golden Age, early forms of proto-capitalism and free markets were
present in the Caliphate, where an early market economy and an early form of
mercantilism were developed between the 8th-12th centuries, which some refer to as
"Islamic capitalism". A vigorous monetary economy was created on the basis of the
expanding levels of circulation of a stable, high-value currency (the dinar) and the
integration of monetary areas that were previously independent.

A number of economic concepts and techniques were applied in early Islamic

banking, including bills of exchange, the first forms of partnership (mufawada) such as
limited partnerships (mudaraba), and the earliest forms of capital (al-mal), capital
accumulation (nama al-mal), cheques, promissory notes, trusts (see Waqf), transactional
accounts, loaning, ledgers and assignments. Organizational enterprises independent from
the state also existed in the medieval Islamic world, while the agency institution was also
introduced during that time. Many of these early capitalist concepts were adopted and
further advanced in medieval Europe from the 13th century onwards.

The coming into being of interest-free banks

The first private interest-free bank, the Dubai Islamic Bank, was also set up in
1975 by a group of Muslim businessmen from several countries. Two more private banks
were founded in 1977 under the name of Faisal Islamic Bank in Egypt and the Sudan. In
the same year the Kuwaiti government set up the Kuwait Finance House.
 However, small scale limited scope interest-free banks have been tried before.
One in Malaysia in the mid-forties and another in Pakistan in the late-fifties… In 1962
the Malaysian government set up the “Pilgrim’s Management Fund” to help prospective
pilgrims to save and profit. The savings bank established in 1963 at Mit-Ghamr in Egypt
was very popular and prospered initially and then closed down for various reasons.
However this experiment led to the creation of the Nasser Social Bank in 1972. Though
the bank is still active, its objectives are more social than commercial

In the ten years since the establishment of the first private commercial bank in
Dubai, more than 50 interest-free banks have come into being. Though nearly all of them
are in Muslim countries, there are some in Western Europe as well: in Denmark,
Luxembourg, Switzerland and the UK. Many banks were established in 1983 and 1984.
The numbers have declined considerably in the following years.

In most countries the establishment of interest-free banking had been by private

initiative and was confined to that bank. In Iran and Pakistan, however, it was by
government initiative and covered all banks in the country. The governments in both
these countries took steps in 1981 to introduce interest-free banking. In Pakistan,
effective 1st January 1981 all domestic commercial banks were permitted to accept
deposits on the basis of profit-and-loss sharing (PLS). New steps were introduced on
1 January 1985 to formally transform the banking system over the next six months to one
based on no interest. From 1 July 1985 no banks could accept any interest bearing
deposits, and all existing deposits became subject to PLS rules. Yet some operations were
still allowed to continue on the old basis. In Iran, certain administrative steps were taken
in February 1981 to eliminate interest from banking operations. Interest on all assets was
replaced by a 4 percent maximum service charge and by a 4 to 8 percent ‘profit’ rate
depending on the type of economic activity. Interest on deposits was also converted into a
‘guaranteed minimum profit.’ In August 1983 the Usury-free Banking Law was
introduced and a fourteen-month change over period began in January 1984. The whole
system was converted to an interest-free one in March 1985.