Research Report on Islamic Banking by Mohamed Ariff, University
of Malaya, taken from Asian-Pacific Economic Literature, Vol. 2,
No. 2 (September 1988), pp. 46-62
Islamic banking is a new phenomenon that has taken many
observers by surprise. The whole banking system has been
islamized in both Iran and Pakistan. In addition, there are some
thirty Islamic banks in operation in other parts of the globe,
including the Jeddah-based Islamic Development Bank (IDB) but
excluding numerous non-bank Islamic financial institutions (see
Appendix). What is more, the speed with which Islamic banks have
sprung up and the rate at which they have progressed make it
worth-while to study them systematically. An attempt is made in
this paper (a) to survey the growing literature on Islamic
banking, in particular (b) to trace the growth and development
of Islamic banking, and (c) to highlight its salient
characteristics.
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Evolution The first modern experiment with Islamic banking was
undertaken in Egypt under cover, without projecting an Islamic
image, for fear of being seen as a manifestation of Islamic
fundamentalism which was anathema to the political regime. The
pioneering effort, led by Ahmad El Najjar, took the form of a
savings bank based on profit-sharing in the Egyptian town of Mit
Ghamr in l963. This experiment lasted until l967 (Ready l98l),
by which time there were nine such banks in the country. These
banks, which neither charged nor paid interest, invested mostly
by engaging in trade and industry, directly or in partnership
with others, and shared the profits with their depositors
(Siddiqi l988). Thus, they functioned essentially as saving-
investment institutions rather than as commercial banks. The
Nasir Social Bank, established in Egypt in l97l, was declared an
interest-free commercial bank, although its charter made no
reference to Islam or Shariah (Islamic law).
The IDB was established in l974 by the Organization of Islamic
Countries (OIC), but it was primarily an inter-governmental bank
aimed at providing funds for development projects in member
countries. The IDB provides fee- based financial services and
profit-sharing financial assistance to member countries. The IDB
operations are free of interest and are explicitly based on
Shariah Principles In the seventies, changes took place in the
political climate of many Muslim countries so that there was no
longer any strong need to establish Islamic financial
institutions under cover. A number of Islamic banks, both in
letter and spirit, came into existence in the Middle East, e.g.,
the Dubai Islamic Bank (l975), the Faisal Islamic Bank of Sudan
(l977), the Faisal Islamic Bank of Egypt (l977), and the Bahrain
Islamic Bank (l979), to mention a few. The Asia-Pacific region
was not oblivious to the winds of change. The Philippine Amanah
Bank (PAB) was established in l973 by Presidential Decree as a
specialized banking institution without reference to its Islamic
character in the bank's charter. The establishment of the PAB
was a response by the Philippines Government to the Muslim
rebellion in the south, designed to serve the special banking
needs of the Muslim community. However, the primary task of the
PAB was to assist rehabilitation and reconstruction in Mindanao,
Sulu and Palawan in the south (Mastura l988). The PAB has eight
branches located in the major cities of the southern Muslim
provinces, including one in Makati (Metro Manila), in addition
to the head office located at Zamboanga City in Mindanao. The
PAB, however, is not strictly an Islamic bank, since
interest-based operations continue to coexist with the Islamic
modes of financing. It is indeed fascinating to observe that the
PAB operates two 'windows' for deposit transactions, i.e.,
conventional and Islamic. Nevertheless, efforts are underway to
convert the PAB into a full-fledged Islamic bank (Mastura l988).
Islamic banking made its debut in Malaysia in l983, but not
without antecedents. The first Islamic financial institution in
Malaysia was the Muslim Pilgrims Savings Corporation set up in
l963 to help people save for performing hajj (pilgrimage to
Mecca and Medina). In l969, this body evolved into the Pilgrims
Management and Fund Board or the Tabung Haji as it is now
popularly known. The Tabung Haji has been acting as a finance
company that invests the savings of would-be pilgrims in
accordance with Shariah, but its role is rather limited, as it
is a non-bank financial institution. The success of the Tabung
Haji, however, provided the main impetus for establishing Bank
Islam Malaysia Berhad (BIMB) which represents a full- fledged
Islamic commercial bank in Malaysia. The Tabung Haji also
contributed l2.5 per cent of BIMB's initial capital of M$80
million. BIMB has a complement of fourteen branches in several
parts of the country. Plans are afoot to open six new branches a
year so that by l990 the branch network of BIMB will total
thirty-three (Man l988).
Reference should also be made to some Islamic financial
institutions established in countries where Muslims are a
minority. There was a proliferation of interest-free savings and
loan societies in India during the seventies (Siddiqi l988). The
Islamic Banking System (now called Islamic Finance House),
established in Luxembourg in l978, represents the first attempt
at Islamic banking in the Western world. There is also an
Islamic Bank International of Denmark, in Copenhagen, and the
Islamic Investment Company has been set up in Melbourne,
Australia. contd at..
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