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RECENT HISTORY OF ISLAMIC BANKING AND FINANCE

RECENT HISTORY OF ISLAMIC BANKING AND FINANCE

During the eighteenth, nineteenth and the first half of the twentieth centuries almost all of the world of Islam was colonized by the European countries. They managed the economies and finances of these countries in their own interests and in their own ways. Other than the native elites who had to get involved, the Muslim masses stayed away from interest-based financial institutions. As the national consciousness grew and freedom movements promised to bear fruits during the second half of the last century, the urge to manage their affairs in accordance with their own values and traditions also emerged in these countries. Indonesia gained independence in 1945 and Algeria in 1963. In between these two dates, all Muslim majority countries became independent. The discussion on the management of their respective economies in order to promote their own interests had, as an offshoot, brought the Islamic financial movement into being. While nationalism made them focus on rapid economic development, religion, the other motivating force in freedom struggle, made many turn to Islam for guidance.

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ISLAMIC BANKING- AN ANALYTICAL ESSAY

ISLAMIC BANKING- AN ANALYTICAL ESSAY

Modern banking system was introduced into the Muslim countries at a time when they were politically and economically at a low ebb, in the late 19th century. The main banks in the home countries of the imperial powers established local branches in the capitals of the subject countries and they catered mainly to the import export requirements of the foreign businesses. The banks were generally confined to the capital cities and the local population remained largely untouched by the banking system. The local trading community avoided the foreign banks both for nationalistic as well as religious reasons. However, as time went on it became difficult to engage in trade and other activities without making use of commercial banks. Even then many confined their involvement to transaction activities such as current accounts and money transfers. Borrowing from the banks and depositing their savings with the bank were strictly avoided in order to keep away from dealing in interest which is prohibited by religion.(1)

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THE FOUNDATIONS OF ISLAMIC FINANCE

Friends, colleagues and dear students, thank you for coming. I hope you will not regret the decision. You are about to hear the story of a unique phenomenon.

During the short span of a quarter century, a new way of financial intermediation and investment management emerged and gained a sizeable part of the market – between a fourth and a third – in its home base, the Persian Gulf countries. During the same period it spread far and wide reaching Malaysia and Indonesia in the east and the Americas in the west, and a number of Muslim countries adopted the new system at the state level.

It is interesting to ask why it emerged, how it works, what sustains it and what are its potentialities for you and me and the humanity at large. The query is timely as all is not well with our conventional system of money, banking and finance. It has become increasingly unstable, facing recurrent crises. It has failed to help in reducing the increasing gap between the rich and the poor, within nations and between nations. Many think it is partly responsible for increasing inequality.

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PROBLEMS AND PROSPECTS OF ISLAMIC BANKING AND FINANCE

PROBLEMS AND PROSPECTS OF ISLAMIC BANKING AND FINANCE

During the last few decades of the twentieth century, the period in which Islamic banking and financial institutions were evolving, great changes were taking place in the financial environment. In this lecture I will examine the problems and prospects of Islamic banking in the perspective of these changes. Two changes are most significant, decline in intermediation and resort to more active, rather aggressive management of investment, and world-wide integration of financial markets in the wake of globalization.

The first trend, symbolized by the repeal of Glass-Steagal in the United States, should be advantageous to Islamic finance insofar as financial intermediation was based on interest. Greater involvement of banks/financial institutions in investment management afforded wider scope for using the Islamic financial techniques of profit-sharing, mark up financing, etc.

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THE ECONOMIC SYSTEM OF ISLAM

Islam, being a practical Religion has evolved a complete code of life which has successfully fulfilled the requirements of the changing times, Not only in the social but also in the economic field it has given an ideal lead to the people.

Of all the beneficial principles propounded by Islam, none are more useful for humanity at large than those governing income and expenditure. The main sources of income to the Islamic Exchequer are Zakat, Ghanimhh, Jizyah (Tithe) and Kharaj. Zakat which literally means growth and purity is a tax on Muslim Capital owned beyond a certain minimum. Zakat occupies an important place amongst the (Farz) Fundamentals of Islam, the observance of which is binding on Muslims. It is an ordinance (Farz).

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ISLAMIC BANKING

Islamic Banking

Happy the man who far from schemes of business, like the early generations of mankind, ploughs and ploughs again his ancestral land with oxen of his own breeding, with no yoke of usury on his neck – Horace

Background

The London Sunday Times of February 2nd 1997 wrote: “The advent of Islamic Finance will be a Godsend for them . It could also turn out to be a goldmine for the United Bank of Kuwait”.

There seems to be considerable demand for such Islamic banking products both in Islamic countries and in the West. To date, for a number of reasons including risk-aversion and conservatism, this need has gone largely unfilled.

The purpose of this article is to provide an introduction to “Islamic” banking. It does not attempt to provide a moral justification, rationale or even establish clear rules as to what is Islamic and therefore Halal and what is un-Islamic and therefore prohibited or Haram. But even if the reader has little interest in Islamic Banking per se there are important lessons to be learned from the creative process used to satisfy the Islamic regulations. There are numerous parallels with tax-driven structuring in conventional banking markets. Throughout the article there are references to familiar Western financial instruments.

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HOW THE CENTRAL BANKS CAN ACCOMMODATE ISLAMIC BANKS

The relationship between Islamic banks and central banks was, and still is, rather tense. Islamic banks started in the 1970s in Muslim countries which were dominated by conventional banking systems and governed by western-style banking laws. Commercial banks in these countries, as well as central banks could not accept the idea of a banking system not based on interest (riba). Islamic banks were refused authorisation to operate.

Responding to the pressure of public opinion, however, the only way was to promulgate special laws exempting Islamic banks from the existing banks rules and even from the control of the central banks. Some Islamic banks were set up under the patronage of governmental authorities, which were, by nature, far from the ordinary banking systems. Examples are the Ministry of Social Affairs for the Nassar Social Bank in Egypt and the relevant Ministry of Awkaf (Religious Endowments) for the Faisal Islamic Bank of Egypt and Bahrain Islamic Bank.

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