1.

Introduction The first official experiment with Islamic Banking in the modern era can be traced back to 1963 in the form of Mit Ghamr Bank in Egypt. From that time to the present decade, Islamic Banking has experienced phenomenal growth both in terms of size and the number of players in the market. Islamic Banking is currently being practiced in more than 50 countries. This includes Muslim countries like Malaysia, Pakistan, Saudi Arabia, U.A.E, Iran, Egypt, Bangladesh and Jordan etc as well as Non-Muslim countries like U.K, U.S.A, Luxembourg, Australia, France and Italy etc. In almost all the countries, Islamic Banking is being practiced along with the traditional banking with the exception of Iran where only Islamic Banking is allowed. Recent figures show that Islamic Banks are managing assets worth more than $260 billion according to 2006 figures and is currently growing at around 20%, which is twice more than the growth of conventional banking. This rapid growth of Islamic Banking shows that it is being accepted widely all over the world, which is due to a number of reasons. The potential of Islamic Banking can be recognized from the fact that the banking giants in all parts of the world have also started their Islamic Banking operations and collectively the total assets being managed under Islamic financial services are reportedly exceeding $500 billion, of which almost half the amount is being managed by conventional banks. The objective of this study is to see the evolution of Islamic Banking in different countries including both Muslim and Non-Muslim countries, their current progress and their future prospects regarding Islamic Banking. The countries that have been chosen for this study are Pakistan, Malaysia, Turkey, Iran, U.S.A, U.K, Indonesia and the GCC etc. In the last part, along with the major differences between the two banking systems, the important characteristics of the Islamic Banking System have been highlighted which have enabled it to become an attractive banking system and have helped it achieve the phenomenal growth rate.

1

2. Research Methodology 2.1 The Purpose of the Study The purpose of this study is to show the reasons, which have been the backbone of the recent success of Islamic Banking over conventional banking operations. For this purpose, Islamic Banking Industry growth in different parts of the world had to be analyzed and so explorative study was a better option as the analysis had to be done on the data already available on the Internet and the books written on Islamic Banking. 2.2 Data Collection For the purpose of Data Collection, the following secondary sources have been used; 2.2.3 Articles on Islamic Banking For the purpose of analysis of the undertaken study, articles written by different renowned scholars have been analyzed. These include Muslim as well as Non-Muslim scholars. Most of the articles have been gathered through the Internet and some of them have been gathered for the Central Library of International Islamic University, Islamabad. 2.2.4 Books on Islamic Banking Various books have been studied in order to complete the analysis. Books from local as well as foreign authors have been analyzed. The books were obtained from Central Library of the International Islamic University Islamabad and the Library of NUST Institute of Management Sciences. Some of the books were also accessed through the Internet. 2.2.4 Research papers on Islamic Banking In order to complement the findings of the study, help was also taken from the research papers written by different learned scholars. These papers were gathered mainly from the Internet as well as from the Central Library of the International Islamic University, Islamabad.

2

2.3 Limitations There are certain limitations, which may have affected the results of the study;   Firstly, this study has been completed in a limited time frame. Secondly the data, available both from the books and the Internet, was not up-todate in quite a few cases.  Finally, the data available on Islamic Banking has mainly been obtained only from the following three sources; o Central Library of International Islamic University, Islamabad. o Library of NUST Institute of Management Sciences, Rawalpindi. o Internet.

3

3. Literature Review This research paper presents a theoretical model of an interest-free banking system consistent with the principles of Islam. The main purpose of the paper is to show that the Islamic banking system can be rationalized in a neoclassical framework and that the model underlying Islamic Banking is not different from Western Economic thinking. It has also been argued in the paper that in many circumstances, Islamic banking system would be relatively more stable than the traditional system in face of certain types of shocks. (Islamic Interest-free Banking: A Theoretical Analysis By Mohsin S.Khan) The study evaluates inter-temporal and inter-bank performance of Islamic bank, Bank Islam Malaysia Berhad (BIMB) in profitability, liquidity, risk and solvency and community involvement for the period 1984-1997. Financial ratios are applied in measuring these performances. T-test and F-test are used in determining their significance. The study found that BIMB is relatively more liquid and less risky compared to a group of 8 conventional banks (The performance of Malaysian Islamic bank during 1984-1997: An exploratory study by Abdus Samad & M. Kabir Hassan). With the exception of a study conducted by Metawa and Almossawi (1997), which shows religion as a factor of customers’ choice of Islamic bank in Bahrain, other studies proved otherwise. The evidence from studies conducted in Sudan and Turkey, for example, show that religion is not the main reason for customers selecting Islamic banks (Erol and ElBdour, 1989). Similarly, studies conducted in Malaysia and Singapore find both religion and profit as the reason for people maintaining their relationship with Islamic banks (Haron et. al., 1994; Gerrad and Cunningham, 1997). At present, there are more than 200 interest-free institutions operating in 40 nations worldwide and providing services that are compatible to those services offered by conventional banks. In 1985 this system mobilized an estimated US $5 billion funds, which currently has increased to US $ 80 billion. Western conventional based financial institutions such as Citibank, JP Morgan, Deutsche Bank, ABN Amro and American Express have started introducing interest-free products to customers. Similarly, multinational corporations such as General Motors, IBM and Daewoo Corporation have begun to use interest-free services. (The effects of conventional interest rates and rate of 4

profit on funds deposited with Islamic banking system in Malaysia by Dr.Sudin Haron & Norafifah Ahmad). According to the Office for National Statistics and recent research led by Lloyds TSB show that over 75 percent of British Muslims would prefer a banking system that conforms to Islamic laws rather than adopting Western financial services.( U.K. the Global Center for Islamic Finance? By James Fontanella) According to estimates provided by the General Council for Islamic Banks and Financial Institutions (GCIBFI), pure-play Islamic banks and financial institutions today manage some $260 billion of assets. The Islamic windows and subsidiaries of international banks in the world’s major financial centers; such as New York, London, Paris, Geneva and Tokyo manage a further $200 billion to $300 billion. Islamic Banking did take off, and has in fact enjoyed an average annual growth rate over 10% per annum since it first emerged in the 1970s, according to the GCIBFI. Hayes attributed much of this success to the increasing sophistication of Shariah scholars and the effort put into Islamic financial engineering, as well as the vital motivator of market demand. Though the option of Shariah-compliant banking is to give Muslims an alternative to interest-based conventional finance, Hayes remarked that the series of scandals in corporate America has helped to close the gap between the ethical demands of Muslim and non-Muslim investors. “Unconsciously, conventional finance has been moving towards the societal values of Islamic finance,” he said. In fact, Hayes said that investors in the US are increasingly keen to invest on an ethical basis: “$1 in every $8 invested in the US now follows moral investment criteria.” Such criteria commonly include a prohibition on investing in tobacco stocks or firms publishing pornography. (Drawing the roadmap for Islamic banking 2003 source: website failaka). Islamic Banking is emerging as a small but growing trend among lenders in the United States, as niche players create specialized products and services for Muslims that fall within the tenets of Islamic law, or Shariah. Currently there are three banks that offer Islamic Banking in the U.S., including international giant HSBC (Research), but experts expect that number to rise as the 5

Muslim population grows and the community begins to demand more specialized services. "The rise of Islamic Banking is a sign of the maturity of the Muslim community in America," said Rabiah Ahmed, spokeswomen for the Council of American-Islamic Relations. " The trend is definitely increasing." Pirker said that regional and community banks that have stronger ties to the Muslims in their community would lead the charge. But larger banks are going to have to start branching out to remain competitive. (CNN Money) International banks have already dipped their toes into Islamic financing abroad and found success. Banks such as Citigroup (Research), HSBC and Deutsche Bank (Research) have created Islamic subsidiaries focused on the Middle East and Asia.( Niche banks find growth in Muslim market By Shaheen Pasha) Interest-free banking seems to be of very recent origin. The earliest references to the reorganisation of banking on the basis of profit sharing rather than interest are found in Anwar Qureshi (1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, followed by a more elaborate exposition by Mawdudi in 1950 (1961). Muhammad Hamidullah’s 1944, 1955, 1957 and 1962 writings too should be included in this category. They have all recognised the need for commercial banks and the evil of interest in that enterprise, and have proposed a banking system based on the concept of Mudarabha - profit and loss sharing. In the next two decades interest-free banking attracted more attention, partly because of the political interest it created in Pakistan and partly because of the emergence of young Muslim economists. Works specifically devoted to this subject began to appear in this period. The first such work is that of Muhammad Uzair (1955). Another set of works emerged in the late sixties and early seventies. Abdullah al-Araby (1967), Nejatullah Siddiqi (1961, 1969), al-Najjar (1971) and Baqir al-Sadr (1961, 1974) were the main contributors. A recent International Monetary Fund study by Iqbal and Mirakhor (l987) has found Islamic Banking to be a viable proposition that can result in efficient resource allocation. The study suggests that banks in an Islamic system face fewer solvency and liquidity risks than their conventional counterparts. The multi-purpose and extra-commercial 6

nature of the Islamic Banking operation does not seem to pose intractable problems. The abolition of interest makes it imperative for Islamic banks to look for other instruments, which renders operations outside the periphery of commercial banking unavoidable. Islamic banks are no exception, having capitalized on the tremendous boom in the Middle East in general, and Islamic Banking in particular. Take some of the larger players as examples: Qatar Islamic Bank (QIB) made $129 million, Dubai Islamic Bank (DIB) made $192 million, Kuwait Finance House (KFH) made $259 million, Bank AlJazira made $359 million, and Al Rajhi Bank made a staggering $941 million. (Robin Wigglesworth 2006) Most of the major Islamic banks in the region are investing tremendous resources into becoming regional, even international, banking players. Bahrain-based ABG is probably the most geographically diversified Islamic bank, with subsidiaries in Egypt, Lebanon, Sudan, Tunisia, Turkey, Jordan, Algeria, and South Africa, and has invested in the Islamic Bank of Britain and the European Islamic Investment Bank. Al Rajhi has announced plans to open 50 branches in Malaysia, arguably the world's most advanced country within Islamic finance, and as in Saudi Arabia, Al Rajhi's focus in Malaysia will be on retail.(Source: Website cpifinancial.net) Khan (1986) has noted that the abolition of interest-based transactions is not a subject alien to Western economic thought. Fisher (1945), Simons (1948), and Friedman (1969) have argued that the current one-sided liability, interest-based financial system can be fundamentally unstable. There are many such examples; the German hyperinflation of the 1920s, oil shock inflation’s in Europe of the 1970s; and banking crises in Japan, East Asia, Russian and Argentina default and Enron bankruptcy, and so on. The occurrence of crises is the result of a complex of factors emanating from over exuberance, greed, underestimation of risk, overexposure, currency failures, asset depreciation, faulty regulation, illiquidity, macroeconomic shocks and accountancy maladministration. Zarqa (1983), Khan (1986), Chapra, (2000) El-Gamel (2000) and Abdul Gafoor (1997), have illustrated the macroeconomic stability that can form a profit and loss sharing system, an Islamic form of banking would replace interest-based transactions that characterize Western transactions.

7

Although Islam excludes interest earnings from financial activities, it does not necessarily mean that the financier cannot earn a profit. In order to do so, the financier has to ensure that gains made on the original amount are directly related to the risk undertaken on the investment (Siddiqui 1987). If there is no risk involved, the gains made represent interest rather than profit. The paper discusses the efficiency of eighteen different banks and concludes that the efficiency of the Islamic banks has been better than the conventional counterparts. The author has used Data Envelopment Analysis technique to arrive at this conclusion. The Islamic banks have performed better than their conventional banking rivals after the 1998-99 crises. (Efficiency in Islamic Banking: An empirical analysis of eighteen banks, Islamic Economic Studies by Donsyah Yudistra 2004) Following a framework of functional perspective suggested by Merton and Bodie (1993) the writers argue that one hundred percents reserve narrow banking provides a basis for banking reforms and an alternative to reduce the likelihood of systemic financial crisis. Both the narrow banking and the Islamic system (equity based system) provide more stability to a banking sector than a conventional banking system does. Banking crisis have provoked immediate proposals from a multitude of foreign advisors as well as from international institutions. To resolve the crisis and to prevent future ones these advisors have called for more and better bank regulation, more and better supervision and more and better enforcement. The authors of the research paper also says that the policy of more regulation does not address two fundamental problems: The asymmetry between the real value of banks assets and liabilities when there are macro-economic shocks and the inherent stability of system of fractional reserve requirements, the Achilles heel of any banking system. As stated by sjaastad (1997) “both deposit insurance and the lender of last resort facility offered by central banks have evolved as devices to stabilize an inherently unstable institution: fractional reserve banking”. During the last centuries countries worldwide experience many episodes of several banking distress and crisis. The US for instance after experiencing bank panics in 1884, 1890, 1893 and 1907 implemented a corrective measure creating in 1913, the federal reserve system. It also imposed a system of deposit insurance as a mechanism to

8

counteract a banking instability. Nonetheless, the Federal Reserve System failed to prevent the worst banking crisis in US history, the great depression of 1930s. In response to this situation, during the 1930s a group of economists affiliated with the University of Chicago launched a proposal for the alternative banking reform now known as narrow banking. The advocated financial system one based on equity thereby separating the creation of money from the creation of credit. Equity based banking system have never explicitly being out into effect in the western world. Nonetheless in some countries with Islamic population due to religious concerns with the payment of interest there are banks based on equity under the Islamic law. Those banks have instituted a scheme that the liability side overcomes the payment of interest through a profit loss-sharing (PLS) scheme. For very different reason the Islamic Banking system and the western call for banking reforms meet on a common ground: equity. One of the most critical features of Islamic Banking is that all the players share profit and losses. The Islamic Banking system avoids one of the most important causes of banking distress that is the asymmetry between the value of assets and the value of liabilities. Muslims are one of the many minorities in Australia. Though there are no Islamic banks in Australia at the moment but a study has shown that there is great potential that if Islamic Banking were introduced in the country, the Muslim community of Australia would appreciate it. Today Australia’s Muslims come from diverse social political and ethnic backgrounds. In 1991 there were 147,500 Muslims in Australia, and in 1996 the number stood at 200,900. In 2001 (the last official census date), there were 281,578 Muslims representing 1.5% of the total population. This studied showed that the majority of the Muslim community is demanding Riba free banking and if offered, would switch to the Islamic Banking products (Islamic Banking in Australia: Challenges and Opportunities by Abdul Malik Mirza And Abdel-Karim Halabi)

9

4. Concept of Riba in Islam

4.1 Riba and Its Types The word "Riba" means excess, increase or addition, which if correctly interpreted according to Shariah terminology, implies any excess compensation without due consideration. This definition of Riba is derived from the Quran and has been unanimously accepted by all Islamic scholars. There are two types of Riba, identified to-date by Islamic scholars, namely 'Riba An Nasiyah' and 'Riba Al Fadl'. 'Riba An Nasiyah' is defined as excess, which results from predetermined interest, which a lender receives over and above the principal. 'Riba Al Fadl' is defined as excess compensation without any consideration resulting from a sale of goods. During the dark ages, only the first form (Riba An Nasiyah) was considered to be Riba. However the Holy Prophet also classified the second form (Riba Al Fadl) as Riba. The meaning of Riba has been clarified in the following verses of Quran:

"O those who believe, fear Allah and give up what still remains of the Riba if you are
believers. But if you do not do so, then be warned of war from Allah and His Messenger. If you repent even now, you have the right of the return of your capital; neither will you do wrong nor will you be wronged." Al Baqarah 2:278-9 These verses clearly indicate that the term Riba means any excess compensation over and above the principal which is without due consideration. However, the Quran has not altogether forbidden all types of excess; as it is present in trade as well, which is permissible. The excess that has been rendered haram in Quran is a special type termed as Riba. In the dark ages, the Arabs used to accept Riba as a type of sale, which unfortunately is also being understood at the present times. Islam has categorically made a clear distinction between the excess in capital resulting from sale and excess resulting from interest. The first type of excess is permissible but the second type is forbidden and rendered Haram.

10

"Seized in this state they say: 'Buying and selling is but a kind of interest', even though
Allah has made buying and selling lawful, and interest unlawful." Al Baqarah 2:275 4.1.1 Classification of Riba   The first and primary type is called Riba An Nasiyah or Riba Al Jahiliya. The second type is called Riba Al Fadl, Riba An Naqd or Riba Al Bai.

Since the first type was specified in the Quranic verses before the sayings of the Holy Prophet, this type was termed as Riba Al Quran. However the second type was not understood by the Quranic verses alone but also had to be explained by the Holy Prophet, so it is also called Riba Al Hadith. Riba An Nasiyah is the real and primary form of Riba. Since the verses of Quran have directly rendered this type of Riba as haram, it is called Riba Al Quran. Similarly, since only this type was considered Riba in the dark ages, it has earned the name of Riba Al Jahiliya. Imam Abu Bakr Hassas Razi has outlined a complete and prohibiting legal definition of Riba An Nasiyah in the following words: "That kind of loan where specified repayment period and an amount in excess of capital is predetermined." One of the Hadith quoted by Ali Ibn at Talib (RAA) has defined Riba An Nasiyah in similar words. The Holy Prophet said: "Every loan that draws interest is Riba." The famous Sahabi Fazala Bin Obaid has also defined Riba in similar words: "Every loan that draws profit is one of the forms of Riba" The famous Arab scholar Abu Ishaq Az Zajjaj also defines Riba in the following words: "Every loan that draws more than its actual amount" Riba An Nasiyah refers to the addition of the premium, which is paid to the lender in return for his waiting as a condition for the loan and is technically the same as interest. The prohibition of Riba An Nasiyah is one of those issues, which have been confirmed, in the revealed laws of all Prophets (AS). Some of the old testaments have rendered Riba as haram (Exodus 22:25, Leviticus 25:35-36, Deuteronomy 23:20, Psalms 15:5, Proverbs 28:8, Nehemiah 5:7 and Ezekiel 18:8,13,17 & 22:12). The Quran has also stated the 11

prohibition of Riba in various verses has warned those, who persist in practicing it, of a war which is certain to be declared on them by Allah Himself and His messenger and has seriously threatened those engaged as writer, witness and dealer in Riba transactions. 4.2 Riba in Quran and Hadith The debate on definition of Riba, particularly in context of present interest-ridden economic and financial system, is almost settled among overwhelming majority of the Islamic scholars since late 1970s. Considering that modern institutionalized form of interest falls under absolute prohibition of Riba, efforts have been going on for about three decades for implementing Islamic Banking System. However, still there might be some confusion in the minds of some individuals. Although some indications of displeasure against Riba were given in the Makkan period, but Islam imposed the prohibition sometime before the battle of Ohud in year 3 A. H. Owing to the fact that interest is a focal point in modern economic life, and specially that it is embedded in operations of existing financial institutions, a number of Muslims have been interpreting it in a manner which is radically different from the understanding of Muslim scholars throughout the last fourteen centuries and that is also sharply in conflict with the categorical statements of the Holy Prophet (peace be upon him). According to Islamic teachings, any excess on the capital is Riba (interest). Islam accepts no distinction, in so far as prohibition is concerned, between ‘reasonable’ and ‘excessive’ rates of interest and interest in any case is prohibited. 4.2.1 Riba in the Quran Riba has been clearly and explicitly prohibited in the Qur’an and Sunnah. Allah and His Messenger, Prophet Muhammad (P.B.U.H), have declared war on those who do not abstain from it. These are some of the relevant verses regarding Riba. Allah says in the Qur'an:  First Revelation (Surah al-Rum, verse 39)

12

"That which you give as interest to increase the peoples' wealth increases not with
God; but that which you give in charity, seeking the goodwill of God, multiplies manifold." (30: 39)  Second Revelation (Surah al-Nisa', verse 161) for their taking interest even though it was forbidden for them, and their

"And

wrongful appropriation of other peoples' property. We have prepared for those among them who reject faith a grievous punishment" (4: 161)  Third Revelation (Surah Al 'Imran, verses 130-2)

"O believers, take not doubled and redoubled interest, and fear God so that you may
prosper. Fear the fire which has been prepared for those who reject faith, and obey God and the Prophet so that you may receive mercy."  Fourth Revelation (Surah al-Baqarah, verses 275-81)

"Those who benefit from interest shall be raised like those who have been driven to
madness by the touch of the Devil; this is because they say: "Trade is like interest" while God has permitted trade and forbidden interest. Hence those who have received the admonition from their Lord and desist, may keep their previous gains, their case being entrusted to God; but those who revert shall be the inhabitants of the fire and abide therein forever." (275)

"God deprives interest of all blessing but blesses charity; He loves not the ungrateful
sinner." (276)

"Those who believe,
(277)

perform good deeds, establish prayer and pay the zakat, their

reward is with their Lord; neither should they have any fear, nor shall they grieve."

"0, believers, fear Allah, and give up what is still due to you from the interest (usury),
if you are true believers." (278)

13

"If you do not do so, then take notice of war from Allah and His Messenger. But, if
you repent, you can have your principal. Neither should you commit injustice nor should you be subjected to it." (279)

"If the debtor is in difficulty, let him have respite until it is easier, but if you forego
out of charity, it is better for you if you realize." (280)

"And fear the Day when you shall be returned to the Lord and every soul shall be
paid in full what it has earned and no one shall be wronged " (281). 4.2.2 Riba in Hadith The Prophet (P.B.U.H) has also expressed his view on Riba on different occasions. These views can be categorized as follows: 4.2.2.1 General The following hadith are those which have been quoted by various suhabaa and refer to Prophet’s general views on Riba:  From Jabir: The Prophet, said about the receiver and the payer of interest, the one who records it and the two witnesses to the transaction: "They are all alike [in guilt]." (Muslim, Kitab al-Musaqat, Bab la'ni akili al-Riba wa mu'kilihi; also in Tirmidhi and Musnad Ahmad)  Jabir ibn ‘Abdallah, giving a report on the Prophet's Farewell Pilgrimage, said: The Prophet addressed the people and said, "All of the Riba of Jahiliyyah is annulled. The first Riba that I annul is our Riba, that accruing to 'Abbas ibn 'Abd al-Muttalib [the Prophet's uncle]; it is being cancelled completely." (Muslim, Kitab al-Hajj, Bab Hajjati al-Nabi, ; may also in Musnad Ahmad)  From 'Abdallah ibn Hanzalah: The Prophet, said: "A dirham of Riba which a man receives knowingly is worse than committing adultery thirty-six times" (Mishkat al-Masabih, Kitab al-Buyu', Bab al-Riba, on the authority of Ahmad and

14

Daraqutni). Bayhaqi has also reported the above hadith in Shu'ab al-iman with the addition that "Hell befits him whose flesh has been nourished by the unlawful."  From Abu Hurayrah: The Prophet, said: "On the night of Ascension I came upon people whose stomachs were like houses with snakes visible from the outside. I asked Gabriel who they were. He replied that they were people who had received interest." (Ibn Majah, Kitab al-Tijarat, Bab al-taghlizi fi al-Riba; also in Musnad Ahmad)  From Abu Hurayrah: The Prophet, said: "Riba has seventy segments, the least serious being equivalent to a man committing adultery with his own mother." (Ibn-e- Majah) 4.2.2.2 Riba an Nasiyah These are the Hadith that are specifically related to Riba an Nasiyah and have been quoted by Prophet’s suhabaas.  From Usamah ibn Zayd: The Prophet, said: "There is no Riba except in Nasiyah [waiting]." (Bukhari, Kitab al-Buyu', Bab Bay' al-dinari bi al-dinar nasa'an; also Muslim and Musnad Ahmad) "There is no Riba in hand-to-hand [spot] transactions." (Muslim, Kitab al-Musaqat, Bah bay'i al-ta'ami mithlan bi mithlin; also in Nasa'i)  From Ibn Mas’ud: The Prophet, said: "Even when interest is much, it is bound to end up into paltriness." (Ibn Majah, Kitab al-Tijarat, Bab al-taghlizi fi al-Riba; also in Musnad Ahmad)  From Anas ibn Malik: The Prophet, said: "When one of you grants a loan and the borrower offers him a dish, he should not accept it; and if the borrower offers a ride on an animal, he should not ride, unless the two of them have been previously accustomed to exchanging such favours mutually." (Sunan al-Bayhaqi, Kitab al-Buyu', Bab kulli qardin jarra manfa'atan fa huwa Riban)

15

From Anas ibn Malik: The Prophet, said: "If a man extends a loan to someone he should not accept a gift." (Mishkat, on the authority of Bukhara's Tarikh and Ibn Taymiyyah's al-Muntaqa) From Abu Burdah ibn Abi Musa: I came to Madinah and met 'Abdallah ibn Salam who said, "You live in a country where Riba is rampant; hence if anyone owes you something and presents you with a load of hay, or a load of barley, or a rope of straw, do not accept it for it is Riba." (Mishkat, reported on the authority of Bukhari)

4.2.2.3 Riba al FadI The following are the Hadith that have been quoted by different suhabaas related to the concept of Riba al Fadl  From 'Umar ibn al-Khattab: The last verse to be revealed was on Riba and the Prophet, was taken without explaining it to us; so give up not only Riba but also raibah [whatever raises doubts in the mind about its rightful-ness]. (Ibn Majah,)  The Prophet, said:

"Sell

gold in exchange of equivalent gold, sell silver in

exchange of equivalent silver, sell dates in exchange of equivalent dates, sell wheat in exchange of equivalent wheat, sell salt in exchange of equivalent salt, sell barley in exchange of equivalent barley, but if a person transacts in excess, it will be usury (Riba). However, sell gold for silver anyway you please on the condition it is hand-to-hand (spot) and sell barley for date anyway you please on the condition it is hand-to-hand (spot)."  From Abu Sa'id al-Khudri: The Prophet, said: "Do not sell gold for gold except when it is like for like, and do not increase one over the other; do not sell silver for silver except when it is like for like, and do not increase one over the other; and do not sell what is away [from among these] for what is ready." (Bukhari, Kitab al-Buyu', Bab bay'i al-fiddati bi al-fiddah; also Muslim, Tirmidhi, Nasa'i and Musnad Ahmad)  From 'Ubada ibn al-Samit: The Prophet, said: "Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt - like for like, 16

equal for equal, and hand-to-hand; if the commodities differ, then you may sell as you wish, provided that the exchange is hand-to-hand." (Muslim, Kitab alMusaqat, Bab al-sarfi wa bay'i al-dhahabi bi al-waraqi naqdan; also in Tirmidhi)  From Abu Sa'id al-Khudri: The Prophet, said: "Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt - like for like, and hand-to-hand. Whoever pays more or takes more has indulged in Riba. The taker and the giver are alike [in guilt]." (Muslim, ibid; and Musnad Ahmad)  From Abu Sa'id and Abu Hurayrah: A man employed by the Prophet, in Khaybar brought for him janibs [dates of very fine quality]. Upon the Prophet's asking him whether all the dates of Khaybar were such, the man replied that this was not the case and added that "they exchanged a sa' [a measure] of this kind for two or three [of the other kind]". The Prophet, replied, "Do not do so. Sell [the lower quality dates] for dirhams and then use the dirhams to buy janibs. [When dates are exchanged against dates] they should be equal in weight. " (Bukhari, Kitab alBuyu', Bab idha arada bay'a tamrin bi tamrin khayrun minhu; also Muslim and Nasa'i)  From Abu Sa’id: Bilal brought to the Prophet, some barni [good quality] dates whereupon the Prophet asked him where these were from. Bilal replied, "I had some inferior dates which I exchanged for these - two sa's for a sa'." The Prophet said, "Oh no, this is exactly Riba. Do not do so, but when you wish to buy, sell the inferior dates against something [cash] and then buy the better dates with the price you receive." (Muslim, Kitab al-Musaqat, Bab al-ta'ami mithlan bi mithlin; also Musnad Ahmad)  From Fadalah ibn 'Ubayd al-Ansari: On the day of Khaybar he bought a necklace of gold and pearls for twelve dinars. On separating the two, he found that the gold itself was equal to more than twelve dinars. So he mentioned this to the Prophet, who replied, "It [jewellery] must not be sold until the contents have been valued separately." (Muslim, Kitab al-Musaqat, Bab bay'i al-qiladah fiha khara-zun wa dhahab; also in Tirmidhi and Nasa'i) 17

These verses from the Quran and the Hadith taken from different sources show the orders for prohibition of Riba and the consequences if a Muslim deliberately indulges in it. Therefore, these verses clearly indicate that a Conventional Banking System is inadequate for the Muslims and should be replaced with a system conforming to their faith.

5. Islamic Banking Islamic Banking refers to a system of banking or banking activity that is consistent with Islamic law (Shariah) principles and guided by Islamic economics. In particular, Islamic law prohibits usury, the collection and payment of interest, also commonly called Riba in Islamic discourse. Generally, Islamic law also prohibits trading in financial risk (which is seen as a form of gambling). In addition, Islamic law prohibits investing in businesses that are considered haram (such as businesses that sell alcohol or pork, or businesses that produce un-Islamic media). 5.1 The Rationale of Islamic Banking

It has been seen that the role and functions of the conventional banks are indeed highly useful and socially desirable, but unfortunately, interest plays a central role in each of their functions, which is prohibited, for all the Muslims. Islamic Banking services endeavor to replace interest by other modes and instruments both for mobilizing savings and for putting those savings to productive use. People need banking services. Now, since the banking services are needed but interest is prohibited, Islamic economies have to find alternative ways of performing various banking functions. This challenge provides the Rationale of Islamic Banking. 5.2 History of Banking in Islam

18

Historically, the role of a financial intermediary in the Islamic economy has been found in the principle of al Mudarib udarib. It is a practice which has existed in Islamic history since early centuries. Al Mudarib is the one who mobilizes funds on profit-sharing basis and extends these funds to the users on the same basis. Similarly in leasing, the lessee who possesses the goods may sell them against a higher price and create additional value. In the early Islamic period, most caravan trades were financed by Mudarabah. In trading it is possible to purchase something on order at a given price and resell it to the other at a higher price. Islamic scholars consider the earnings of profits from an intermediary role as a genuine occupation. It should be noted that this concept of financial intermediation is related with the production and exchange of real goods and services. In short, it can be said that the concept of financial intermediary has existed in Islamic world since centuries. 5.3 Evolution of Modern Islamic Banking

The latter half of the twentieth century witnessed a distinctly separate line of thinking on banking. This was institutionalized at the end of third quarter and subsequently emerged as a new system of banking called Islamic Banking, which is also called Profit-Loss Sharing (PLS) Banking. The world has now been experiencing operations of as many as 250 Islamic Banks and financial institutions in more than 50 Muslim and Non-Muslim countries. There are religious as well as economic reasons which have contributed to the emergence of PLS system as an alternative to its conventional counterpart. It is the prohibition of Riba in the Quran that according to the proponents of the PLS system was the source of inspiration for establishing banks in line with Islam. The basic intention behind establishing Islamic banks was the desire of Muslims to reorganize their financial activities in a way that do not contradict the principles of Shariah and enable them to conduct their financial transactions without indulging into Riba.

19

The economic reason derived from a verse of the Quran providing inspiration to devise an interest-free financial system has been substantiated in the way that interest instead of increasing wealth, reduces it [30:34]. The primary reason of why the Quran has taken such a strict approach towards prohibition of interest is that Islam stands for establishing a just economic system free from all kinds of exploitation. Summing, Islamic Banking emerged as a response to both religious and economic demands while religious demand calls for avoiding any transaction based on interest, economic exigencies on the other hand provide a new outlook to the role of banking in promoting productive investment activities, influencing distribution of wealth and adding stability to the economy. Islamic Banking is thus perceived as an improved system in all dimensions. 5.3.1 First Islamic Banking Experiment The pioneering experiment of putting the principles of Islamic Banking and finance into practice was conducted in Egypt from 1963 to 1967 through the establishment of the Mit Ghamr Savings Bank in a rural area of the Nile Delta. Although the project made a good start and initial results were more than encouraging, it suffered a setback owing to changes in the political atmosphere. Nevertheless the project was revived in 1971 under the name of Nasser Social Bank. This was the first Islamic bank in an urban setting based in Cairo. The bank has been established as a public authority with an autonomous status. The principles of operation of the Nasser Social Bank are very similar to those of the Mit Ghamr Savings bank. However the latter offers a full range of normal banking services and a wide range of investment activities through equity participation. 5.3.2 Tabung Hajji: The First Successful Attempt Islamic Banking with a very different approach from that in Egypt emerged in Malaysia. It was a financial institution developed for the pilgrims of Malaysia. Consequently pilgrims saving corporation was established in 1963 which was later on incorporated into 20

the pilgrims management fund board by the name Tabung Hajji in 1969 (A.Ahmad 1993). Other attempt next to follow was the Dubai Islamic bank in 1975. The Dubai Islamic bank was established as a public limited company having its office in Dubai U.A.E. Since then, a number of Islamic banks and financial institutions have been established in different parts of the world and have been functioning successfully. A significant development in Islamic Banking was the granting of an Islamic bank license in Saudi Arabia to the fifty-year-old “Al-Rajhi Company” which became the country’s first Islamic bank. An example of multi-cooperation at the government level in the field of Islamic Banking is the Islamic Development Bank, which was founded in 1975 as a multi-national corporation by several Muslim countries. The purpose of the bank is to support social and economic development in Muslim nations within an Islamic framework. The subscribers of the capital are the founder governments and as such it was established by government treaty. In addition an Islamic bank and Investment company was established in Bahamas in 1977 as a multinational holding company under the name of Islamic Investment Company Limited. Another example of Islamic Banking in the west comes from Luxembourg where the Islamic Banking System international holding was established in 1978 as a joint-stock company. As a holding company, it established a new affiliated company in London in June 1983 under the name of Islamic finance house and another in Denmark in 1982 under the name of the Islamic bank international of Denmark. Dar-al-mal-al-islami (DMI) based in Geneva was established in 1981. Another major group is the Kuwait finance house (KFH). It was established in 1978. The Kuwait Government was the major shareholder whereas private Kuwait investors owned the remainder of Forty-nine percent of the KFH.

21

Another dynamic Islamic Banking conglomerate is the Al-Baraka group, which operates banks, investment companies, and financial advisory and management companies in more than a dozen countries. It launched its activities only in 1982 but the group now has a total asset base of over $ 8.64 billion. It was the first group to obtain a license to launch Islamic Banking in London.

5.4 Objectives of Islamic Banking

The primary objective of establishing Islamic banks all over the world is to promote, foster and develop the application of Islamic principles in the business sector. More specifically, the objectives of Islamic Banking when viewed in the context of its role in the economy are listed as following:   To offer contemporary financial services in conformity with Islamic Shariah To contribute towards economic development and prosperity within the principles of Islamic justice.   Optimum allocation of scarce financial resources and To help ensure equitable distribution of income.

These objectives are discussed below; 5.4.1 Offer Financial Services Interest-bearing banking, which is considered a practice of Riba in financial transactions, is unanimously identified as anti-Islamic. That means all transactions made under conventional banking are unlawful according to Islamic Shariah. Thus emergence of Islamic Banking is clearly intended to provide for Shariah approved financial transactions. 5.4.2 Islamic Banking for Development

22

Islamic Banking is claimed to be more development-oriented than the conventional counterpart. The concept of profit sharing is a built-in development promoter since it establishes a direct relationship between the bank’s return on investment and the successful operation of the business by the entrepreneurs.

5.4.3 Optimum Allocation of Resources Another important objective of Islamic Banking is the optimum allocation of scarce resources. The foundation of the Islamic Banking system is that it promotes the investment of financial resources into those projects that are considered to be the most profitable and beneficial to the economy. 5.4.4 Islamic Banking for Equitable Distribution of Resources Perhaps the most important objective of Islamic Banking is to ensure equitable distribution of income and resources among the participating parties: the bank, the depositors and the entrepreneurs. 5.5 Modes of Islamic Banking The main modes in Islamic Banking are discussed below, 5.5.1 Mudarabah Mudarabah is a profit sharing enterprise. It is an arrangement or an agreement between two parties where one acts as the capital provider while the other is the entrepreneur. The capital provider is called the rass al-mal while the entrepreneur is called the Mudarib. The Mudarib mobilizes the funds for a previously agreed upon business venture. Any profits from this venture are shared between both the parties in an agreed upon ratio. Any losses, 23

if incurred are born by the capital provider. This arrangement continues until such time as the loan is repaid. An executive partner can also put-in his capital if others agree. 5.5.2 Musharakah A Musharakah agreement operates in the same way as a joint venture. It is a partnership, normally of limited duration. Some regard it as the purest form of Islamic financial instrument, since it conforms to the underlying partnership principles of sharing in and benefiting from risk. Profits are divided on a pre-agreed upon basis, and any losses are shared according to the equity participation ratio. This concept is distinct from fixedincome investing (i.e. issuance of loans). 5.5.3 Murabahah Murabahah can be called a cost plus profit contract. This concept refers to the sale of goods at a price, which includes a profit margin agreed by both parties. The purchase and selling price, other costs and the profit margin must be clearly stated at the time of the sale agreement. The bank is compensated for the time value of its money in the form of the profit margin. This is a fixed-income loan for the purchase of a real asset (such as real estate or a vehicle), with a fixed rate of mark-up determined by the profit margin. The bank is not compensated for the time value of money outside of the contracted term (i.e. the bank cannot charge additional interest on late payments), however the asset remains in the ownership of the bank until the loan is paid in full. 5.5.4 Ijarah Islamic banks frequently practice Ijarah or Islamic leasing. Ijarah as applied by Islamic banks include the requirement that the leased items be used productively and in ways permitted by Islamic law. Under this mode, the banks buy the equipment or machinery and lease it out to their clients. Ijarah customers have an option for eventually purchasing the leased product in which case the monthly payments consist of rental payments plus 24

installments toward the purchase price. Lessor throughout the lease period retains ownership, risk and ownership, except in the case when loss is caused by misuse or negligence by lessee. Consumable items cannot be leased. 5.5.5 Al-Wadiah In Al-Wadiah mode of financing, a bank is deemed as a keeper and trustee of funds. A person deposits funds in the bank and the bank guarantees refund of the entire amount of the deposit, or any part of the outstanding amount, when the depositor demands it. The depositor, at the bank's discretion, may be rewarded with a gift termed ‘hibah’ as a form of appreciation for the use of funds by the bank. In this case, the bank compensates depositors for the time-value of their money (i.e. pays mark-up) but refers to it as a "gift" because it does not officially guarantee payment of the gift. The bank may also at its absolute discretion pay the depositors a positive return periodically, depending on its own profitability. Such payment is considered lawful in Islam since it is not a condition for lending by the depositors to the bank, nor is it predetermined. The savings account holders are issued with savings books and are allowed to withdraw their money as and when they please. 5.5.6 Bai' mu’ajjal Islamic banks have also been resorting to purchase and resale of properties on a deferred payment basis, which is termed bai' mu’ajjal. It is considered lawful in fiqh (jurisprudence) to charge a higher price for a good if payments are to be made at a later date. According to fiqh, this does not amount to charging interest, since it is not a lending transaction but a trading one. The risk stays with the seller until the time of delivery and the purchaser has a right of inspection and may reject on sight if he doesn’t agree with the description as specified at the time of contract.

25

5.5.7 Bai' salam Pre-paid purchase of goods is also an area where Islamic banks are particularly active. This is termed bai'salam and is a means used by Islamic banks to finance production. Here the price is paid at the time of the contract but the delivery would take place at a future date. This mode enables an entrepreneur to sell his output to the bank at a price agreed upon in advance. Islamic banks, in keeping with modern times, have extended this facility to manufacturers as well. 5.5.8 Muqarada Muqarada allows banks to float specific type of Islamic bonds, which are then used to finance specific projects. In keeping with Islamic principles, these are no interest bonds. The investors obtain their return through the profits that the investments generate. The profit- sharing is done through a predetermined ratio and at the same time the investors also share any losses that might result from the investment. The investors have no share in the management of the project.

5.6 Challenges Faced By Islamic Banks 5.6.1 Central Banks and Supervision Many central banks in region where Islamic banks are functioning do not have legislations or the tools and procedures needed to supervise those Islamic banks. Lack of understanding and experience of Islamic bank’s transactions as well as the lack of regulations make it difficult for Islamic banks to adapt to the structure and procedures specified by the central banks. This situation has changed in many countries notably Turkey, Jordan and Malaysia where specific laws for the establishment of Islamic banks have already been issued. In many other countries the regulations for Islamic banks are being finalized.

26

5.6.2 Shortage of Experts in Islamic Banking The supply of trained or experienced bankers is lagging behind the expansion of Islamic Banking. The training needs are affecting the operations of Islamic Banks in both, Muslim as well as Non-Muslim Countries. There are very few institutes all over the world, which are providing education in Islamic Banking. This number should be increased and this can be done through funding of international organizations such as Islamic Development Bank etc. 5.6.3 Accounting Principles and Procedures Due to the fact that balance sheet of an Islamic banks and the nature of items on it have different interpretations and impact than those of conventional banks, there is a need to understand financial statement from its own perspective. Reliable decision-making can be affected if the statements do not present information fairly i.e. in a way that can be understood by all the interested parties. It seems from the past experience of many accounting firms in auditing the accounting of Islamic banks that certain accounting difficulties had developed specially in matter of due to a lack of accounting standards specific to Islamic banks. In 1989, thus, was established an accounting standard to cater for such rules. Since then, The Accounting And Auditing Organization For Islamic Financial Institutions (AAOIFI) has published several standards, which are being followed by the Islamic banks all over the world. 5.6.4 Absence of Liquidity Instruments Many Islamic banks lack liquidity instruments such as treasury bills and other marketable securities, which could be utilized either to cover liquidity shortages or to manage excess liquidity. This problem is aggravated since many Islamic banks work under operational procedures different from those of the central banks. The resulting non-compatibility prevents the central banks from controlling or giving support to Islamic banks if a liquidity gap should occur. 27

5.6.5 Risk Analysis and Measurement The present infancy of Islamic banks means that their risk analysis and risk measurement techniques have not been developed to an extent necessary. Risk analysis is very important in conventional banking operations and central banks impose certain measures to endure that the banks do not exceed an allowable risk. Though both conventional and Islamic banks share similar risk that needs to be managed such as credit and foreign exchange risk, the Islamic banks differ in the level of such risk. Islamic banks expect to be active in project financing and are expected to monitor investment risk carefully and more prudently than their conventional counterparts. 5.6.6 Product Diversification and Service Quality Many Islamic banks do not have the diversity of products essential to satisfy the growing needs of the client such as structured instruments for financing, trade, leasing and money market instruments. The importance of technology and information in upgrading the acceptability of the product and diversifying its application cannot be over emphasized. Many Islamic banks do not have the necessary expertise and institutional capacity for R&D, which would allow them to develop the needed products. So it’s not surprising that most depend on conventional banks in this regard, hence there is a need to pay significant attention for the development of new innovative Islamic products. 5.6.7 Cost Effectiveness Current competition in the global market makes awareness of the cost effectiveness of bank’s operations essential requirement for the survival of Islamic banks. As competition increases the spread and returns will make banks less competitive. So they could subsequently lose their customer base, it is therefore necessary for Islamic banks to have very efficient costing system and implementation of appropriate advanced technology in order to compete in the global market. 28

5.6.8 Social Role and Duty Many researchers have anticipated and emphasized the social role of Islamic banks that they should contribute positively to essential social needs such as poverty alleviation, granting credit to the poor, donating to charities and helping to achieve real distribution of income. Others have felt that Islamic banks should put the emphasis on social considerations in training and in their operations and play a more dynamic role in the achievement of socio-economic growth. Many banks have been trying to fulfill these expectations but their efforts have been modest and fallen short of the level required. Therefore, Islamic banks should try to justify its true spirit and play its social role. 5.6.9 Competition In today’s world, competition is one of the major forces in any field. In banking too, its importance cannot be under-emphasized. Conventional banks always have the option of copying and introducing similar products as the Islamic banks have in the market. Not only the banks but also the anti-Islamic organizations make it difficult for Islamic banks to grab their respective market share. Therefore, competition is also one of the major challenges.

29

6. Islamic Banking Growth Worldwide In the last decade, Islamic Banking has seen an enormous growth all over the world; according to the statistics the growth rate has been around 20% for the last couple of years. Some of the important countries with respect to the scope of Islamic Banking are discussed below: 6.1 Pakistan The transformation of banking and financial system of Pakistan was started in 1977 in the regime of Gen.Zia-ul-Haq. Pakistan was one of the very few countries that had been trying to implement interest free banking at massive level. The legal framework of Pakistan's financial and corporate system was amended in 1980 to permit issuance of a new interest-free instrument of corporate financing named Participation Term Certificate (PTC). Amendments were also made in the Banking Companies Ordinance, 1962. From July 1, 1985, all commercial banking in Pak Rupees was made interest-free. From that date, no bank in Pakistan was allowed to accept any interest-bearing deposits and all existing deposits in a bank were treated to be on the basis of profit and loss sharing. Deposits in current accounts continued to be accepted but no interest or share in profit or loss was allowed to these accounts. In 2001, the Government decided to open up fullfledged Islamic banks. The State Bank issued detailed criteria in December 2001 for establishment of full-fledged Islamic commercial banks in the private sector. Al Meezan Investment Bank received the first Islamic commercial banking license from State Bank 30

of Pakistan in January 2002. A new clause was also inserted in the Banking Companies Ordinance 1962 by an amendment, which provided that conventional banks could form Islamic Banking branches. From the introduction of Islamic Banking in 2002, the number of Islamic banks has increased to 6, which have opened up 99 branches collectively all over Pakistan. Not only these, but 13 leading conventional banks have also opened up their 58 Islamic Banking branches. The list of these banks and their respective branches can be seen in the appendix. The banking assets of the Islamic banks increased by about 24% in the last quarter of 2006 to about Rs.118 billion. According to the latest figures, around 3% of the banking deposits are with the Islamic banks. Out of the total financing done, 40% of the financing is Murabahah based whereas second is the Islamic leasing, Ijara that is 30% of the total financing. Looking at the progress of Islamic Banking in Pakistan, it can be said that it has a great future in Pakistan and it may be likely in the future that a greater amount of deposits will flow to the Islamic Banking system.

6.2 Malaysia In Malaysia, the introduction of Islamic Banking came with the passing of Islamic Banking Act of Malaysia 1983. The Islamic Banking Act specified four approved modes of Islamic finance i.e. Mudarabah, Murabahah, Musharakah, and Wadia. No return is allowed to be paid on current accounts, although banks are allowed to give customers gifts. The introduction of the new Islamic financial regulations were not aimed at restricting the activities of the existing conventional banks, but at providing a framework within which new, Islamic institutions could operate. The passing of a new Investment Act under which the government undertook to issue short-term certificates paying dividends rather than interest solved the problem of Islamic bank’s access to short-term funds. It is extremely rare that financial authorities in conventional banking markets are willing to develop new regulations to accommodate this liquidity problem. This encouragement from the financial authorities has enabled Malaysia to become the hub of Islamic Banking. 31

Malaysia has used a unique approach of a dual banking system where conventional and Islamic Banking systems exist side by side, and opportunity has been given to all banks to practice Islamic Banking Every bank has to meet certain terms and conditions. Islamic Banking in Malaysia is unique also for the reason that their market is very well developed and has a huge future potential. There are many factors that contribute to the successful growth of Islamic Banking in Malaysia. The first is the encouragement and support of monetary authorities. The second factor is the creativity of financial engineering in designing new products. The third factor at work is the favorable economic conditions of Malaysia, which have resulted in the growth of banking sector as a whole. The Malaysian experience of Islamic Banking has had a spectacular impact on neighboring countries. Brunei Darussalam created its first Islamic bank in 1993. Indonesia established its first Islamic bank in 1992 i.e. Bank Muamalat but the success Malaysia has achieved has been phenomenal. Performance of Malaysian Islamic Banking during Asian Financial Crisis During the Asian Financial Crisis, more than 23 banks and financial institutions in the country were offering Islamic Banking facilities. However, only one of these could be considered as an Islamic bank (Bank Islam Malaysia), while the others were mainly conventional institutions. During the year 1997, Islamic Banking in Malaysia reported progress despite financial crisis: • • • • Assets expanded by 76.5% to RM7.9 billion. Financing recorded a strong growth of 75% to RM10.8 billion. Total deposits mobilized registered a growth of 36.2% to RM9.9 billion The shareholders’ funds of the Islamic bank and the interest-free banking fund amounted to RM1.3 billion, while profit before taxation and zakat amounted to RM153 million in 1997. Growth in total Islamic financing rose sharply, particularly in the second half of 1997. It recorded a moderate growth of 29.5% in the first half of 1997 and was much stronger in the second half of 1997, increasing by 36.7%. 32

Islamic Banking continued to record moderate growth in the next year too. Total deposits mobilized registered a strong growth of 59.1% to RM 16.4 billion during the year. The shareholders’ funds of Islamic bank and the Islamic Banking fund increased by 23% to RM 1.6 billion, while profit before taxation and zakat decreased by 3.3% to RM 148 million in 1998. Total assets expanded by 21% to RM21.6 billion due mainly to the increase in holdings of securities (162.4% or RM3.1 billion). Total financing recorded a growth of 1.8% to RM10.9 billion (For more information, refer to the appendix). Total deposits recorded a strong growth in 1998, particularly in the second half of the year. The increase was partly due to the migration of deposits from conventional banking to Islamic Banking in view of the better investment deposit rates. Investment deposits constituted the bulk of deposits (60.5%), which recorded a growth of 108.9% to RM9.9 billion. In the latest development, Islamic financial systems in Malaysia has grown and improved significantly compared to 23 years ago, went it was first promulgated. Currently there are 35 commercial banks, of which 22 are domestic banks and 13 are foreign-controlled (or 44 percent of total financial system assets), 39 finance companies (14 percent), 12 merchant banks (4 percent), 7 discount houses (2 percent), and money and exchange Brokers. Of these, there are 4 Islamic banks, 12 commercial banks, 7 discount houses, 4 merchant banks and one finance company offering Islamic financial services and products with an estimated total asset amounted US$ 106 billion at the end of 2005. Bank Negara Malaysia (BNM) has also issued three new Islamic Banking licenses to foreign Islamic financial institutions from the Middle East, namely Al Rajhi Banking and Investment Corporation, Kuwait Finance House (Malaysia) Bhd and a consortium of Islamic financial institutions led by Qatar Islamic Bank (inclusive of Qatar Islamic Bank 70%, RUSD Islamic Bank Inc 20% and Global Islamic House 10%). The Malaysian Islamic Banking Industry is one of the most dynamic industries and is leading the Islamic finance right now. There banking model has been very effective and though only 10% of the banking assets are Shariah Compliant currently but there is a huge potential in the future. 6.3 Turkey

33

Islamic banks operate in Turkey under government act 1983. Two authorities make the regulations covering the operations of Islamic banks, one from the Treasury and Foreign Trade Secretariat and the other from the central bank. The two authorities provide very specific guidelines for the operations of the banks. The activities, which the banks are permitted to undertake, are clearly those, which characterize Islamic institutions. The new institutions are licensed as Special Finance Houses rather than banks. In the beginning though the growth of Islamic Banking in Turkey was not very significant and was around 3% only but in recent couple of years the situation is turning around and the total deposit amount has crossed 2 billion Turkish Liras. Before 2003, there were four SFHs in Turkey: Al-Baraka Turkish Finance House, the Faisal Finance Institution, the Kuwaiti Turkish Finance House, and the Anatolian Finance House. After 2003, two more institutions have come i.e. Ihlas Finance Company and Asya Finance Company.

6.4 Jordan In Jordan also, there is a plural system which accommodates both Islamic and traditional banking and financial transactions. The Shariah Law of 1978 has been passed for the establishment of Islamic banks. As a result of passing of this law, the Jordan Islamic Bank was launched in 1978. In 1985 the Jordan Central Bank issued a law called the Jordan Islamic Bank (JIB) for Finance and Investment Law of 1985 which specifies the way the Jordan Islamic Bank could operate. The JIB, the only Islamic bank in Jordan, has an extensive and relatively large branch network. In 2006, it had an asset base of about JD 1.5 billion.

6.5 Iran

Islamic Banking in Iran has flourished after the restructuring of the economy after the 1979 revolution. The structure of the Islamic Banking system was put in place in 1983 by issuing the Interest-Free banking Law of 1983. This law was implemented 1984 and 34

banks were given 18 months to complete transformation to Islamic Banking principles. This shows that the Iran Government was very strict about the implementation of the interest free Islamic Banking system according to the true spirit of Islam. The main Islamic banks of Iran are Bank Saderat and Bank Melli. Though Iran has some differences with that of other countries’ Islamic Banking Systems which are due to its majority of 89% shiaah community, but still it was the first country in the world to switch its banking system to interest-free Islamic Banking System and since then, it has not suffered any crisis, which denotes its success. 6.6 Gulf Coastal Countries

The GCC region financial market as a whole is over-banked, and competition for retail customers is intense. The development of new technological banking products is a priority for many institutions. For this reason, Islamic banking has been seen as a healthy addition to the banking sector of these countries and has seen an enormous growth over the last few years. Regulatory authorities in different countries of the Gulf have dealt with Islamic banks in different ways. But in each case, the main issue has been to make Islamic banks conform to the same liquidity and reserve requirements as conventional banks, which have access to short-term, fixed-interest funds. Islamic banks in the Gulf offer broadly the same range of products as their conventional rivals. There has been great competition among Islamic and conventional banks in the Gulf. This has been due to the fact that Islamic financial institutions are restricted in the kinds of instruments they can offer, whereas their conventional rivals can adapt a financing technique to suit any requirement. Islamic banks are now well-established feature of the banking framework in the Gulf. They have significant market share and a clear niche role. Right now, almost one-third of the Islamic banking assets are from the GCC countries. Below some of the major GCC countries have been discussed;

35

6.6.1 Saudi Arabia Saudi Arabia is a country with about 25 million and a GDP of about $287 billion. Over the years there have been great changes in the banking sector of the Saudi Arabia. The number of products offered by them has increased. According to a survey, it had been seen that the Credit card usage was only 22% and only 11% had personal financing with banks. Penetration of value-added services such as Investment and saving / Insurance Products was very low in 2000, primarily due to the problem of Riba. But gradually with the introduction of Islamic banks the situation has changed a lot and people’s interest in the banking service has improved. More than 30 per cent of bank assets in Saudi Arabia are now classified as Shariah compliant. Officially all the banks are considered to be Islamic but in reality there is only one Islamic bank Al-Rajhi banking investment Corporation. Banks are also not allowed to use the word Islamic with their banks. 6.6.2 U.A.E The banking sector is one of the healthiest sectors of the UAE economy. The number of commercial banks in the UAE has been very steady at 46 banks over the period 19992004. The number of branches has increased by 25% during the same period, to reach 449 branches in 2004. Islamic banking started in the U.A.E in 1975 by the establishment of Dubai Islamic Bank. Today about 5 of the banks are registered as Islamic banks including Dubai Islamic Bank, Abu Dhabi Islamic Bank, Emirates Islamic Bank and National Bank of Sharjah and the National Bank of Dubai whereas many other local and international banks are offering Islamic financial products. Around 20% of the assets are Shariah compliant. 6.6.3 Bahrain Islamic banking entered the country in the form of Bahrain Islamic Bank in 1979 and since then the number of Islamic banks has been increasing. Bahrain right now has the largest number of Islamic banks in the world with almost 26 different financial 36

institutions offering Islamic products. The important Islamic institutions are Al-Baraka bank, First Islamic Investment Bank, Bahrain Islamic Bank, Shamil Bank, Al-Amin Bank. Al-Baraka bank is also one of the largest Islamic institutions in the world. Geneva based UBS launched its Islamic private banking subsidiary, Noriba, which is also based in Bahrain. Other major global players include Citigroup and First Islamic Investment Bank. Bahrain is the only country to have created a legal framework for Islamic banks. The consolidated total assets of the Islamic banks operating in Bahrain as of end-2002 stood at US$2.91bn, an increase of 18.5% over the previous year. The total assets of the Islamic banks grew at a rate of 21.2% for the last five years, and it almost doubled in the past three years. 6.7 U.S.A Islamic Banking has also been introduced to the U.S.A financial market and is being appreciated there as well. The most noticeable is Devon State Bank in Chicago. The Islamic Banking operations of this bank are being run by a prominent Jewish family. The main branch of the bank is situated in a neighborhood of Chicago that has now been transformed into an Indo-Pakistani business hub. The Federal Reserve Banks of Chicago and of New York have taken a keen interest and have been conducting serious research into Islamic Banking. The original work was done at the Federal Reserve Bank of Minnesota almost three years ago. It is interesting to report that the Federal Reserve Bank of New York, in this respect also conducts regular seminars on the subject in New York City to understand what the needs and the compliance hurdles are, while trying to implement Islamic Banking in the US. It is believed that the experience of the Islamic Bank of Britain and the interest of some of the Gulf banks in tapping the US Islamic Banking market are some of the reasons for such an interest. Currently there are three banks that offer Islamic Banking in the U.S.A, including international giant HSBC, but experts expect that number to rise as the Muslim population grows and the community begins to demand more specialized services. Many industry giants for example, G.E and Microsoft have switched over to Islamic financing for their upcoming projects. 37

Though Industry experts are of the opinion that the size of the Islamic Financial market is difficult to determine, yet the growing Muslim population that is almost reaching 7 million is likely to demand Shariah compliant financial products in the future. One of the institutions, University Bank recently formed the University Islamic Financial Corp., a subsidiary that offers Muslims home financing, deposit accounts and Islamic mutual fund shares. It expects to increase its assets to about $100 million by 2010. 6.8 United Kingdom Today United Kingdom has a Muslim population of about 2.5 million with an estimated savings of 1 billion Euros whereas around 500000 Muslim tourists visit the country spending around 600 million Euros. There are almost 360000 Muslim households residing in United Kingdom. According to a survey, the richest 5000 Muslims in the United Kingdom manage assets of around 3.6 Billion Euros. According to a survey, out of the total Muslim population, more than 300000 adults have annual income of more than 30000 Euros, which makes 25% of the adult Muslims attractive customers for financial products and services. In some of areas for example Leicester and Luton, the Muslims have increased to about 20% of the whole population. In fact by another decade, Leicester will become the only city of United Kingdom with more than 50% Muslims. It has been estimated that 8% of the population in London is Muslim, amounting to approximately 725,000 persons. This means that over 30% of the Muslims in the UK live in the London area. The group earning £30000 or more per year basically comprises of these educated professionals. Researches also indicate that these professionals are more knowledgeable of their religious and social roots. Thus, there is a natural inclination among them to align their financial decisions with the Islamic faith. This has resulted in the opening up of Islamic Banking branches in United Kingdom. Islamic Banking in the United Kingdom has been more than a decade old now. Al-Baraka Group of Bahrain was the first institution to enter the market and introduce its Islamic Banking products. Second Islamic bank is the Islamic bank of Britain. Islamic bank of Britain has opened its three branches in London, Leicester and Luton. Other banks to offer Islamic products are HSBC and Lloyds LSB. 38

In 2002, only the Shariah compliant market for mortgages was estimated to be around 7 billion Euros. Of the Muslims earning more than 3000 Euros have around 182000 savings accounts, which if converted to Islamic accounts could make a huge market for Islamic Banking. So in short we can say that the market of United Kingdom possesses a huge potential for Islamic Banking Products and has the potential to maintain its leadership in Non-Muslim countries involved in Islamic Banking practices. 6.9 Other Western Countries Though there are many potential markets where Islamic banks can enter and reap considerable profits but till now, the number is very limited. This can be analyzed from the fact that the European Union has a population of around 20 million out of which only about 2.5 million people reside in United Kingdom. The majority of Muslims is in France and Germany. Taking example from the case of United Kingdom, it is quite evident that there may be a lot of untapped potential in rest of the European countries and if properly utilized could result in a lot of profits for Islamic banks. Another important country, which has given considerable attention towards Islamic Banking, is Luxembourg. In Luxembourg, the Islamic Banking System international holding was established in 1978 as a joint-stock company. As a holding company, it established a new affiliated company in London in June 1983 under the name of Islamic finance house and another in Denmark in 1982 under the name of the Islamic bank international of Denmark. Deutsche Bank of Germany has already many Islamic markets and is offering Shariah compliant products but not in their own country. Italy and Austria have also initiated Islamic banking. So we see that there is a scope but the progress has been a bit slow. But there is a huge potential for Islamic banking in rest of the Europe too.

39

7. Findings 7.1 Differences between Conventional and Islamic Banking

Conventional Banking is essentially based on the debtor-creditor relationship between the depositor and the bank on one hand and between the borrower and the bank on the other. Interest is considered to be the price of credit reflecting the opportunity cost of money. Islamic Banking, on the other hand considers a loan to be given or taken to be free of charge to meet any contingency. Thus in Islamic Banking the creditor shouldn’t take the advantage of borrower. When money is lent out on the basis of interest more often it happens that it leads to some kind of injustice. The first Islamic principle underlines such kind of transactions is that deal not unjustly and ye-shall not be dealt with unjustly [2:279]. Hence commercial banking in Islamic framework is not based on the debtorcreditor relationship. Another principle regarding financial transactions in Islamic Banking is that there shouldn’t be any reward without taking a risk. This principle is applicable to both labor and capital. As no payment is allowed for labor unless it is applied to work there is no reward for capital unless it is exposed to business risk. Thus financial intermediation in an Islamic framework has been developed on the basis of above two principles. Consequently, financial relationships in Islam have been participatory in nature. Several theorists suggest that commercial banking in an interest free system should be organized on the principle of profit and loss sharing. The institutions of interest are thus replaced by a principle of participation in profit and loss. 40

That means a fixed rate of interest is replaced by a variable rate of return based on real economic activity. The distinct characteristics, which provide Islamic Banking with its main points of departure from the traditional interest based commercial banking system, are:  The Islamic Banking system is essentially a profit and loss sharing system and not mainly an interest (Riba) banking system.  Investment (loans and advances in conventional sense) under this system of banking must serve simultaneously both the benefit to the investor and benefit of local community as well. The financial relationship as pointed above is referred to in Islamic Banking as Mudarabah. The distinguishing differences of conventional and Islamic Banking are as below, Firstly we see that the conventional banks borrow funds from the depositors paying interest on the liability side of the balance sheet. Whereas in Islamic Banking, the majority of funds consists of the Partnership (Mudarabah) or profit and loss sharing arrangement between the bank and the depositors. In Conventional Banking, the banks lend the funds to the borrowers, charging higher interest on the asset or investment side. On the other hand, Islamic banks use Profit and loss sharing (Musharakah) or trade based financing arrangement (Mubadalah) between the bank and its investment clients. In Conventional Banking, the depositors are not told where there funds are being invested whereas in Islamic Banking, the banks entitle the depositors   To be informed of what the bank does with their money To have a say in where their money would be invested (Mudarabah-eMuqayyidah)

41

In the traditional system, the interest or the return is predetermined or fixed in advance whereas in Islamic system, the profit or the return is based on the actual investment outcome. Transactions are financial asset based in Conventional Banking whereas these transactions are real asset based in Islamic Banking. The functional and operating modes of conventional banks are based on manmade principle. Whereas the functions as operating modes of Islamic banks are based on the principles of Shariah. The investor is assured of predetermined rate of interest in Conventional Banking hence not encouraging risk taking. In contrast Islamic Banking promotes risk sharing between provider of capital (investor) and user of funds (entrepreneur). Conventional banks aim at maximizing profits without any restrictions. Whereas Islamic banks aims at maximizing profits subject to Shariah restrictions. Conventional banks don’t deal with zakat. Whereas in the modern Islamic Banking System, it has become one of the service-oriented functions of the Islamic banks to collect and distribute zakat. Lending money and getting it back with interest is the fundamental function of conventional bank. Whereas participation in partnership business is the fundamental function of the Islamic banks. The scope of activities of Islamic banks is wider when compared with conventional bank. It is in effect, a multipurpose institution. Conventional banks can charge additional money (compound rate of interest) in case of defaulters. Whereas the Islamic banks have no provision to charge any extra money from the defaulters. 42

Conventional banks growth is mainly based on its interest earnings whereas Islamic banks give due importance to the public interest. Its ultimate aim to ensure growth with equity. For Islamic banks it is comparatively difficult to borrow money from the money market than it is for conventional banks. The conventional banks give greater emphasis on credit worthiness of the clients. The Islamic banks on the other hand give greater emphasis on the viability of the projects. The status of the conventional bank in relation to its client is that of creditor and debtor. Whereas in Islamic bank, the relationship is that of partners, investors and traders. A conventional bank has to guarantee all its deposits. Strictly speaking an Islamic bank cannot do that. Another difference lies in the focus of financial accounting information. While in conventional banks the emphasis is on the on the interest rate spread, provision of loan portfolio and maturities of liabilities, in Islamic banks it is on assets allocation and return from investment and trade. Liquid assets in Islamic banks are almost double that that of conventional counterparts. Here a point to be noted is that Islamic banks also maintain such high liquidity because they can’t use central banks as lenders of last resort due to the incompatibility of the two institutions.

7.2 Islamic Banking- A Superior and Stable Banking System

43

The Islamic Banking System is a progressive and pioneering financing system, working effectively in modern days in many parts of the Muslim as well as Non-Muslim world. In many developed and developing countries this unique financing system is working side by side with other conventional banks. The performance of the banking sectors in these countries has shown that this system has some comparative advantages, which has made it more attractive. Some of the major findings are discussed below, 7.2.1 Islamic Banking- A Practical example of Narrow Banking After the great depression of 1930s, a group of economists affiliated with the University of Chicago launched a proposal for an alternative baking reform now known as “Narrow Banking”. They advocated making the financial system based on equity thereby separating the creation of money from the creation of credit. Equity-based Banking System had never been explicitly put into effect in the western world at that time. After some decades the concept of Equity-based banking started in some countries with Islamic population due to religious concerns for the elimination of interest, banks based on equity started working under the laws of Shariah. Thus the Islamic Banking system and Chicago call for banking reforms on common ground, i.e. equity. According to scholars, Narrow Banking stabilizes the financial system and eliminates the need for fractional reserve requirement and deposit insurance, which ultimately lead in higher spreads. According to a research done by various researchers both the Narrow banking and Islamic system provides for stability to a banking sector than a conventional banking system does. Because Islamic Banking system is equity based it has the ability to avoid one of the most important causes of banking distress and crisis namely the: perverse asymmetry between the value of assets and the value of liabilities. Consequently this system can avoid the moral hazards generated by deposit insurance. As there is no need for deposit insurance, an Islamic Banking System can also eliminate the need for a lender of last resort. As Islamic Banking considers demand and investment deposit as two distinct contracts it can improve the competitiveness of banks and make them more market responsive too. This market responsiveness helps it to make itself more stable.

44

7.2.2 Symmetry of Profit-Loss sharing system According to research, as the Islamic Banking system is based on profit-loss sharing system therefore it can be able to face crisis situations in a better way. Specifically as the depositor is not guaranteed a predetermined rate of return, therefore the depositor’s nominal value is considered to be the share of the depositor in the bank. So both the profits and losses are shared with the depositor. Similarly, on the other side of the balance sheet, the bank cannot charge a fixed rate on its loans and has to engage itself in a profit and loss sharing agreement. Some of the famous American researchers have also agreed upon the fact that equity-based banking system can help in improving the financial stability of the banking system. As the nominal values of deposits and loans can be adjusted in a profit-loss sharing system and not in a traditional system, therefore Islamic banking or profit-loss sharing system has the required flexibility whereas traditional system does not. 7.2.3 Risk Sharing Islamic Banking has a very distinct feature in the respect that it promotes risk sharing between the providers of funds investor on the one hand and both the financial intermediary, the bank and the user of funds entrepreneur on the other hand. If we compare it to conventional banking, the investor is assured of a predetermined interest rate. Since the outcomes of the projects are uncertain, therefore there is always some risk involved. In conventional banking all this risk is borne in principle by the entrepreneur. Whether the project succeeds and produces a profit or fails and results in a loss, the owner of capital gets away with a predetermined return. In Islam, this kind of unjust distribution is not acceptable and hence in Islamic Banking both the investor and the entrepreneur share the results of the project in a way that depends on the supply and demand for funds. In case of profit or loss, both share it in a pre-agreed proportion. 7.2.4 Abolition of Interest

45

Since Riba is prohibited in the Quran and interest in all its forms is akin to Riba as confirmed by fuqaha and Muslim economists with rare exceptions, a very distinguishing feature of an Islamic bank is that it is interest free. This system has been desire for about one-fifth population of the world who want to transact daily transactions with a banking system, which is according to their beliefs. 7.2.5 Moral Dimension and Ethical Perspective Conventional banks generally pay little attention to the moral implications of the activities they are financing. As against this, in the Islamic system everyone has to work within the moral value system of Islam. Islamic banks are no exception. As such they cannot finance any project, which conflicts with the moral value system of Islam. For example, they will not finance a wine factory, a casino, a nightclub or any other activity, which is prohibited by Islam or is known harmful for the society. Also as we know, after cases like Enron and WorldCom have come up, Business ethics have become an everyday concern, and according to research, people who think from an ethical perspective will be more interested in opting for the banking system which is more ethical. 7.2.6 Emphasis on Productivity In case of a conventional bank all that matters to a bank is that its loan and the interest payments are being done on time. Therefore, in granting loans, the important consideration is the credit worthiness of the borrower. Under profit-loss sharing system the bank will receive a return only if the project succeeds and produces a profit. Therefore an Islamic bank will be more concerned with the soundness of the project and the business expertise and managerial competence of the entrepreneur. This feature has important implications for the distribution of credit as well as the stability of the system. This results in reduction of non-performing loans, which is one of the most important issues in banking these days.

46

7.2.7 Multi Purpose Bank Another substantial distinguishing feature is that Islamic banks will be universal or multipurpose banks and not purely commercial banks. These banks are conceived to be a crossbreed of commercial and investment banks investment trusts and investmentmanagement institution and can offer a variety of services to their customers. A substantial part of their financing would be for specific projects or ventures. Their equityoriented investments would not permit them to borrow short-term funds and lend to longterm investments. This makes them less crisis prone compared to their capitalist conventional counterparts since they have to make a greater effort to match the maturity of their liabilities with the maturity of their assets. 7.2.8 Works as a Catalyst of Development Profit sharing being a distinctive characteristic of an Islamic bank fosters closer relations between banks and entrepreneurs. It helps develop financial expertise in non-financial firms and also enables the bank to assume the role of technical consultant and financial advisor which acts as catalyst in the process of industrialization and development. This results in overall development of economy.

47

8. Conclusion This study attempted on highlighting the growth of Islamic Banking taking cases of different countries including the Muslim as well as Non-Muslim countries. After an analysis of different countries including Pakistan, Malaysia, Saudi Arabia, U.S.A, U.K, Bahrain, Jordan, Sudan, Iran and U.A.E to see how Islamic Banking has flourished in these countries, the main differences and the distinguishing features have been discussed which have enabled Islamic Banks in the world to achieve this growth rate of around 20%. Now it can be concluded that the Islamic Banking System has the required traits that can pose a major threat to the traditional banking system. In the long run, it can be said that Islamic banking assets can replace a major portion of the conventional banking assets and this profit-loss sharing system can replace the interest based banking system.

48

9. Bibliography Book and Articles  Mohsin S.Khan (1986) “Islamic Interest-free Banking: A Theoretical Analysis” IMF Staff Papers  Babikir Osman Ahmed (1997) “Islamic Banking In Practice”. Islamic Research and training Institute, Islamic Development bank, Jeddah  Abdel-Haq M Al-Omer Fuad (1996) “Islamic Banking” Oxford University Press Karachi.  Garcia F Cibils V Maino R (2004) “Remedy For Banking Crises:What Chicago And Islam Have In Common” Islamic Economic Studies Vol 11 No2.  Ahmed Ausaf (1997) “Structure of Deposits in Selected Islamic Banks” (Implications for deposit Mobilization). Islamic Research And Training Institute, Islamic Development bank Jeddah  Ahmed, A. (1983) “Evolution of Islamic Banking”, Institute of Policy Studies, Lahore, Pakistan  Ahmad,K.A.(1993), “Elimination Of Riba From The Economy”, Institute of Policy Studies, Lahore, Pakistan  Ahsan fakhrul,A.S.M. (1989), “Islamic Banking in Perspective.” Islami Bank Bangladesh Limited, Dhaka, Bangladesh  Ahmad, Ziauddin (1994). “Islamic Banking: State of the Art”. Islamic Economic Studies,Vol.2 No.1.Islamic Research and Training Institute, Islamic Development Bank, Jeddah  Ahmad,Ziauddin, Khan,M.Fahim and Iqbal Munawar.(1983) “Money and Banking in Islam” Islamabad: Institute of Policy Studies.

49

Al Jarhi Ali Mabid And Iqbal Munawar(2001) “Islamic Banking” Answers to Some Frequently Asked Questions”. Islamic Research and Training Institute, Islamic Development Bank. Jeddah Babikir Osman Ahmed (1997) “Islamic Financial Instruments To Manage ShortTerm Excess Liquidity”. Islamic Research and training Institute,Islamic Development bank, Jeddah Gathura, G.(1996), “Banking On Islam”. (Growth of Islamic Banking), World press review, May 1996. Hmoud,Sami hasan(1994).”Progress of Islamic Banking: the aspirations and the realities.” Islamic Economic Studies,Vol.2 No.1.Islamic Research and Training Institute, Islamic Development Bank, Jeddah Heffernan,S (1999) “Modern Banking In Theory and Practice”, Wiley & Sons Ltd.England Iqbal Munawar,Ahmed Ausaf and Khan Tariqullah(1998) “Challenges facing iskamic banking” Islamic Research And Training Institute, Islamic Development Bank. Jeddah Kamel Shah (1998), “Development of Islamic Banking”, Islamic Research And Training Institute, Islamic Development Bank. Jeddah Kazarian,E.(1991), “Finance And Economic Development, Islamic Banking In Egypt”,Lund Economic Studies,No 45. Khan,M.Akram(1989). “A survey of Critical Literature On Interest-Free banking”.Journal of Islamic Banking and Finance, Karachi Khan M Fahim (1991) “Comparative Economics of Some Islamic Financing Techniques”. Islamic Research and Training Institute, Islamic Development Bank. Jeddah Khan,M.S. (1986) “Islamic interest free banking”. Staff papers, International Monetary Fund Mangla,I.U. and Uppal,J.Y.(1990).” Islamic Banking: A Survey And Some Operational issues”. The International Institute of Islamic Thought.

50

Nassief N. (1998,” Islamic Banking around the World, Islami Bank Bangladesh Limited, Dhaka, Bangladesh Siddiqi H Israr (1975) “Practice and Law of Banking In Pakistan”. Siddiqi M.N (1973) “Banking without Interest” Islamic Publication Lahore Usmani Ashraf Imran(2002) “Meezan banks Guide To “Islamic Banking”

  

Websites www.alltheweb.com www.google.com www.wikipedia.org www.alrajhibank.com.sa www.albaraka.com.pk www.amanahfinance.hsbc.com www.fallaka.com www.faysalbank.com www.hifip.harvard.edu www.cnnmoney.com www.isdb.org.sa www.iiff.net www.islamibankbd.com www.islamic-banking.com www.islamicconferences.com www.islamic-finance.net www.islamicity.com www.islamicbankingnetwork.com www.ihilal.com www.laRiba.com www.meezanbank.com www.muslim-investor.com www.sbp.com.pk

51

Appendices Appendix I

Source: Islamic Bank of Britain

52

Appendix II

Source: Islamic Bank of Britain

53

Appendix III

Source: Islamic Bank of Britain

54

Appendix IV

Islamic Banking in Malaysia: Key Data – 1996 -19997 (RM million) As at end of 1996 Total assets: All financial institutions Islamic Bank Total deposits All financial institutions Islamic Bank Total financing All financial institutions Islamic Bank Financing-deposit ratio % All financial institutions 10133 (3962) 7264 (3283) 6143 (2400) 84.6 17881 (5202) 9895 (3223) 10750 (3351) 108.6 (104.0) 63.5 (22.0) 47.5 (19.6) 75.9 (22.1) 12.7 (- 0.7) 76.5 (31.3) 36.2 (-1.8) 75.0 (39.6) 24.1 (30.9) 1997 % change 1996 1997

Islamic Bank (73.1) Source: Bank Negara Malaysia – 1997.

55

Appendix V Islamic Banking: Deposits by Type and Institutions – Malaysia Annual change 1996 RM % Current deposits Commercial banks Islamic bank Savings deposits Commercial banks Finance companies Islamic bank Investment deposits Commercial banks Finance companies Merchant banks million 509 373 136 524 293 58 173 1304 256 529 291 50.8 19.7 58.3 86.9 32.4 43.1 23.4 1997 RM million 1808 334 398 223 132 425 789 As at end-1997 3319 2159 1160 1821 853 129 839 4755 2141 1041 349 1224

% 119.7 215.2 40.4 28.0 35.4 50.0 18.7 9.8 58.4 18.3 0.3 -30.1

119.6 1474

207.1 43

150.7 161 510.5 1

Islamic bank 228 15.0 -526 Source: Bank Negara Malaysia, Annual Report – 1997.

56

Appendix VI

Source SBP Website

57

Table of Contents
Acknowledgements………..…………………………….………………………………...I Abstract…………………………………………………………………….……………..II 1. INTRODUCTION.........................................................................................................1 2. RESEARCH METHODOLOGY.................................................................................2 2.1 THE PURPOSE OF THE STUDY...........................................................................................2 2.2 DATA COLLECTION.........................................................................................................2 2.2.3 Articles on Islamic Banking................................................................................2 2.2.4 Books on Islamic Banking..................................................................................2 2.2.4 Research papers on Islamic Banking.................................................................2 2.3 LIMITATIONS............................................................................................................3 3. LITERATURE REVIEW.............................................................................................4 4. CONCEPT OF RIBA IN ISLAM...............................................................................10 4.1 RIBA AND ITS TYPES....................................................................................................10 4.1.1 Classification of Riba.......................................................................................11 4.2 RIBA IN QURAN AND HADITH........................................................................................12 4.2.1 Riba in the Quran.............................................................................................12 4.2.2 Riba in Hadith..................................................................................................14 5. ISLAMIC BANKING..................................................................................................18 5.1 THE RATIONALE OF ISLAMIC BANKING............................................................................18 5.2 HISTORY OF BANKING IN ISLAM.....................................................................................18 5.3 EVOLUTION OF MODERN ISLAMIC BANKING.....................................................................19 5.3.1 First Islamic Banking Experiment....................................................................20 5.3.2 Tabung Hajji: The First Successful Attempt....................................................20 5.4 OBJECTIVES OF ISLAMIC BANKING..................................................................................22 5.4.1 Offer Financial Services...................................................................................22 5.4.2 Islamic Banking for Development....................................................................22 5.4.3 Optimum Allocation of Resources....................................................................23 5.4.4 Islamic Banking for Equitable Distribution of Resources................................23 5.5 MODES OF ISLAMIC BANKING........................................................................................23 5.5.1 Mudarabah.......................................................................................................23 5.5.2 Musharakah......................................................................................................24 5.5.3 Murabahah.......................................................................................................24 5.5.4 Ijarah................................................................................................................24 5.5.5 Al-Wadiah.........................................................................................................25 5.5.6 Bai' mu’ajjal.....................................................................................................25 5.5.7 Bai' salam.........................................................................................................26 5.5.8 Muqarada.........................................................................................................26 5.6 CHALLENGES FACED BY ISLAMIC BANKS........................................................................26 5.6.1 Central Banks and Supervision........................................................................26 58

5.6.2 Shortage of Experts in Islamic Banking...........................................................27 5.6.3 Accounting Principles and Procedures............................................................27 5.6.4 Absence of Liquidity Instruments.....................................................................27 5.6.5 Risk Analysis and Measurement.......................................................................28 5.6.6 Product Diversification and Service Quality...................................................28 5.6.7 Cost Effectiveness.............................................................................................28 5.6.8 Social Role and Duty........................................................................................29 5.6.9 Competition......................................................................................................29 6. ISLAMIC BANKING GROWTH WORLDWIDE..................................................30 6.1 PAKISTAN....................................................................................................................30 6.2 MALAYSIA..................................................................................................................31 6.3 TURKEY .....................................................................................................................33 6.4 JORDAN.......................................................................................................................34 6.5 IRAN...........................................................................................................................34 6.6 GULF COASTAL COUNTRIES ..........................................................................................35 6.6.1 Saudi Arabia.....................................................................................................36 6.6.2 U.A.E................................................................................................................36 6.6.3 Bahrain.............................................................................................................36 6.7 U.S.A........................................................................................................................37 6.8 UNITED KINGDOM........................................................................................................38 6.9 OTHER WESTERN COUNTRIES........................................................................................39 7. FINDINGS....................................................................................................................40 7.1 DIFFERENCES BETWEEN CONVENTIONAL AND ISLAMIC BANKING..........................................40 7.2 ISLAMIC BANKING- A SUPERIOR AND STABLE BANKING SYSTEM........................................43 7.2.1 Islamic Banking- A Practical example of Narrow Banking.............................44 7.2.2 Symmetry of Profit-Loss sharing system..........................................................45 7.2.3 Risk Sharing......................................................................................................45 7.2.4 Abolition of Interest .........................................................................................45 7.2.5 Moral Dimension and Ethical Perspective.......................................................46 7.2.6 Emphasis on Productivity.................................................................................46 7.2.7 Multi Purpose Bank..........................................................................................47 7.2.8 Works as a Catalyst of Development................................................................47 8. CONCLUSION............................................................................................................48 9. BIBLIOGRAPHY........................................................................................................49 BOOK AND ARTICLES..........................................................................................................49 WEBSITES.........................................................................................................................51 APPENDICES..................................................................................................................52 APPENDIX I.......................................................................................................................52 APPENDIX II......................................................................................................................53 APPENDIX III....................................................................................................................54 APPENDIX IV....................................................................................................................55 APPENDIX V......................................................................................................................56 APPENDIX VI....................................................................................................................57 59

TABLE OF CONTENTS................................................................................................58

60

Sign up to vote on this title
UsefulNot useful