Evolution of Islamic Banking in the world and the privileges it offers. Explain and illustrate in the worldwide aspect.



1.1  Introduction:

Muslims boast that theirs is a religion that is not technically a “religion” at all: it’s a way of life. Being a Muslim, as it turns out, is a major lifestyle choice. Islam is not limited to a set of rituals and worships that promise heaven and God’s gratification in the life hereafter. It also gives precise guidelines on how to lead one’s life.

It has laws in every aspect of life. Business and finance is also covered in Islam. Islamic banking, as I have explained later, is a banking system that is interest-free and totally Sharia compliant.

In a world filled with “Islamophobia” (!), Islamic banking is actually on the rise, mainly in the developed world.

This report explains why this is so the privileges of Islamic banking. It sheds lights on the evolution of Islamic banking worldwide and how its current trends.

Islamic banking system has emerged as a competitive and a viable substitute for the conventional banking system during the last three decades. It is especially true for Muslim world where presently Islamic banking strides at two separate fronts. At one side, efforts are also underway to cover the entire financial systems in accordance to Islamic laws (Shariah). At the other side, separate Islamic banks are allowed to operate in parallel to conventional interest based banks. Pakistan and Malaysia are the two good examples of above mentioned approaches.

Both countries adopted different tracks for the same ultimate destination of developing full fledge viable Islamic financial system and produced quite interesting results. The Government of Pakistan tried to cover the entire financial system to an interest free system through presidential orders at a national level. However, the overnight practice of islamization didn’t achieve the required success. Most of the efforts have either been reversed or further developments have been stopped. Malaysia opted for the alternative gradual way of developing and implementing Islamic banking system. Starting with one Islamic bank it later allowed conventional financial institutions to offer and participate in Islamic banking products and services through their existing staff and branches. The country is now actively involved in designing new Islamic financial instruments for capital and money market transactions. This study provides the comparative analysis of implementing two opposite Islamic banking approaches, one in Pakistan and other in Malaysia along with their acquired results.

1.2   Brief History & Evolution of Islamic Banking:

 Although mediation goes back hundreds of years, alternative dispute resolution has grown rapidly in the United States since the political and civil conflicts of the 1960s. The introduction of new laws protecting individual rights, as well as less tolerance for discrimination and injustice, led more people to file lawsuits in order to settle conflicts[1]. For example, the Civil Rights Act of 1964 outlawed “discrimination in employment or public accommodations on the basis of race, sex, or national origin. Laws such as this gave people new grounds for seeking compensation for ill treatment. At the same time, the women’s movement and the environmental movements were growing as well, leading to another host of court cases. The result of all these changes was a significant increase in the number of lawsuits being filed in U.S. courts. Eventually the system became overloaded with cases, resulting in long delays and sometimes procedural errors[2]. Processes like mediation and arbitration soon became popular ways to deal with a variety of conflicts, because they helped relieve pressure on the overburdened court system.

 The first instance of Islamic banking came into the picture in Egypt in 1963. The pioneering efforts by Ahmad El Najjar brought this bank into existence, whose key principle was profit sharing (non-interest based philosophy of Shariah). By the end of 1976 there were 9 such banks in the country. These banks neither charged nor paid interest but their activities were mostly limited to trade and industries where these banks invested directly or as partners of depositors. Hence, functionally these banks were working more as financial institutions rather commercial banks. In 1971, Nazir Social Banks is known to be the first commercial bank in Egypt, though its charter never made references to Shariah. The first bank explicitly based on Shariah principles was established by the Organization of Islamic countries (OIC) in 1974, called Islamic Development Bank (IDB). This bank was primarily engaged in intergovernmental activities for providing funds for development projects running into member countries. Its business model involved fees for financial services and profit sharing financial assistance for projects.

With time, during the 1970s several Islamic banks came into existence, including the Dubai Islamic Bank (first Islamic private commercial bank, 1975), the Faisal Islamic bank of Sudan (1977) and the Bahrain Islamic bank (1979). Others from the Asia Pacific region include the Philippine Amanah Bank (PAB), formulated under presidential decree. Pakistan also had an established Islamic banking system at the time which unfortunately didn’t survive.

Within a decade of the first private bank coming into existence in Dubai, the global industry had more than 50 such banks in the same country. Most banks were a result of private initiatives, whereas the first concrete government initiative was taken by the Iranian government, when in 1985 no bank was permitted to give or take interest. Interests was replaced with service charges of 4-8% and guaranteed minimum profits.

The true phase of development of Islamic financial institutions actually occurred in the 1980s. Earlier initiatives were more inclined towards interest free Islamic banking, but the emergence of financial systems has evolved in the 80s. However, non-payment of interest still remains the pivotal part of Islamic banking, whereas principles of Islamic finance such as property rights, sanctity of contracts and the rules of sharing risk are also supported. In 1985, the High Council of OIC (Organization of Islamic Conference) declared takaful / Islamic insurance as Shariah compliant. The new, wider spectrum of Islamic finance covers not only banking activities but also capital markets, capital formation and other financial instruments and intermediaries.

The biggest change in terms of adaptability came in 1991 when the Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) was established to advise on Islamic finance standards all over the world. Later, the development of uniform standards was supported by other organizations such as Islamic Financial Services Board (IFSB) in Malaysia in 2002.

Since then, Islamic finance is spreading all over the world at a tremendous pace from virtual anonymity to becoming a powerful competitive force in the world today.

1.3 Historical development:

It seems that the history of interest-free banking could be divided into two parts. First, when it still remained an idea; second, when it became a reality — by private initiative in some countries and by law in others. We will discuss the two periods separately. The last decade has seen a marked decline in the establishment of new Islamic banks and the established banks seem to have failed to live up to the expectations. The literature of the period begins with evaluations and ends with attempts at finding ways and means of correcting and overcoming the problems encountered by the existing banks.

1.3.1 Interest-free banking as an idea

Interest-free banking seems to be of very recent origin. The earliest references to the reorganization 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).2 Muhammad Hamidullah’s 1944, 1955, 1957 and 1962 writings too should be included in this category. They have all recognized 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.3

Early seventies saw the institutional involvement. Conference of the Finance Ministers of the Islamic Countries held in Karachi in 1970, the Egyptian study in 1972, First International Conference on Islamic Economics in Mecca in 1976, International Economic Conference in London in 1977 were the result of such involvement. The involvement of institutions and governments led to the application of theory to practice and resulted in the establishment of the first interest-free banks. The Islamic Development Bank, an inter-governmental bank established in 1975, was born of this process.

1.3.2 The coming into being of interest-free banks

The first private interest-free bank, the Dubai Islamic Bank, was also set up in 1975 by a group of Muslim businessmen from several countries. Two more private banks were founded in 1977 under the name of Faisal Islamic Bank in Egypt and the Sudan. In the same year the Kuwaiti government set up the Kuwait Finance House.

However, small scale limited scope interest-free banks have been tried before. One in Malaysia in the mid-forties4 and another in Pakistan in the late-fifties.5 Neither survived. In 1962 the Malaysian government set up the “Pilgrim’s Management Fund” to help prospective pilgrims to save and profit.6 The savings bank established in 1963 at Mit-Ghamr in Egypt was very popular and prospered initially and then closed down for various reasons.7 However this experiment led to the creation of the Nasser Social Bank in 1972. Though the bank is still active, its objectives are more social than commercial.8, 9

In the ten years since the establishment of the first private commercial bank in Dubai, more than 50 interest-free banks have come into being. Though nearly all of them are in Muslim countries, there are some in Western Europe as well: in Denmark, Luxembourg, Switzerland and the UK. Many banks were established in 1983 (11) and 1984 (13). The numbers have declined considerably in the following years.10

In most countries the establishment of interest-free banking had been private by initiative and confined to that bank. In Iran and Pakistan, however, it was by government initiative and covered all banks in the country. The governments in both these countries took steps in 1981 to introduce interest-free banking. In Pakistan, effective 1 January 1981 all domestic commercial banks were permitted to accept deposits on the basis of profit-and-loss sharing (PLS). New steps were introduced on 1 January 1985 to formally transform the banking system over the next six months to one based on no interest. From 1 July 1985 no banks could accept any interest bearing deposits, and all existing deposits became subject to PLS rules. Yet some operations were still allowed to continue on the old basis. In Iran, certain administrative steps were taken in February 1981 to eliminate interest from banking operations. Interest on all assets was replaced by a 4 percent maximum service charge and by a 4 to 8 percent ‘profit’ rate depending on the type of economic activity. Interest on deposits was also converted into a ‘guaranteed minimum profit.’ In August 1983 the Usury-free Banking Law was introduced and a fourteen-month change over period began in January 1984. The whole system was converted to an interest-free one in March 1985.11

1.3.3 The last decade

The subject matter of writings and conferences in the eighties have changed from the concepts and possibilities of interest-free banking to the evaluation of their performance and their impact on the rest of the economy and the world. Their very titles bear testimony to this and the places indicate the world-wide interest in the subject. Conference on Islamic Banking: Its impact on world financial and commercial practices held in London in September 1984, Workshop on Industrial Financing Activities of Islamic Banks held in Vienna in June 1986, International Conference on Islamic Banking held in Tehran in June 1986, International Conference on Islamic Banking and Finance: Current issues and future prospects held in Washington, D.C. in September 1986, Islamic Banking Conference held in Geneva in October 1986, and Conference ‘Into the 1990’s with Islamic Banking’ held in London in 1988 belong to this category. The most recent one is the Workshop on the Elimination of Riba from the Economy held in Islamabad in April 1992.

Several articles, books and PhD theses have been written on Islamic Banking during this period. Special mention must be made of the work by M. Akram Khan in preparing annotated bibliographies of all published (and some unpublished) works on Islamic Economics (including Islamic Banking) from 1940 and before. It is very useful to students of Islamic Economics and Banking, especially since both English and Urdu works are included (1983, 1991, 1992). M.N. Siddiqi’s bibliographies include early works in Arabic, English and Urdu (1980, 1988). Turkish literature is found in Sabahuddin Zaim (1980).

1.4              Islamic Banking in Bangladesh:

Bangladesh, apart from its Muslim population of 140 million, has also put in place an Islamic banking infrastructure for Bank Islam to start its operations should there be a merger or acquisition. It is a market that is similar to Indonesia, he said.

He said Bank Islam’s overseas expansion model would involve acquiring Islamic banks rather than conventional banks. This is to avoid operational issues involving non-Shari’ah income from the businesses of the conventional banks during the transition period.

Zukri said Bank Islam prefers to work with a local party, who would be familiar with the local market and the regulatory environment, adding a controlling stake is not a requirement but preferred, provided it is not costly to the bank.

On the bank’s acquisition of a 20 per cent stake in Sri Lanka-based Amana Bank Ltd, he said: “It’s a good decision to go to Sri Lanka. We are upbeat about the potential and we expect this investment to break even after two years.”

At birth, Bangladesh inherited an interest based banking system, which was introduced here earlier when the country was a part of British Colony. Since its inception Bangladesh saw a new trend in banking both at home and abroad. Islamic banking was successfully tries in Egypt. Naser Social Bank was in the process of establishment after the Mit Ghamar Model. During the seventies, Islamic Development Bank (IDB) and a number of Islamic banks at national levels were established in the Islamic world. At home, the Islamic groups were vigorously working for adoption of Islam as the complete code of life. They found Islamic banking in ready form of immediate introduction. Two professional bodies “Islamic Economics Research Bureau” (IERB) and “Bangladesh Islamic Bankers Association” (BIBA) were taking practical steps for imparting training on Islamic Economics and banking to a group of bankers and arranging some national and international seminars/workshops to mobilize local and foreign people and attract investors to come forward to establish Islamic bank in Bangladesh. Their professional and right-thought activities were reinforces by a number of Muslim entrepreneurs working under the aegis of Muslim Businessman Society 9MBS. The body concentrated mainly in mobilizing equity capital for the emerging Islamic bank. Due to continuous and dedicated work of the above groups and individuals and active support from the Government, Islamic banking could be established in early eighties. Islamic banks have been operating in Bangladesh for about one and half decade alongside with the traditional banks. Out of over 39 banks only five banks (including one foreign Islamic bank) and two Islamic banking branches of a traditional bank, Prime Bank Limited (PBL) have been working on Islamic principles. Like any other traditional commercial banks, they do mobilize deposits and produce loans. But their modes of operation was based on shari’ah is different from the other traditional commercial banks.

CHAPTER II             

                Concepts, Perspective & Privileges of Islamic Banking

2.1 Concepts, Terminologies & Principles of Islamic Banking:

To understand the benefits of Islamic banking and its evolution, we first we need to know the major notions of Islamic banking.

2.1.1 Definition of Islamic Banking

Islamic banking is based on Shariah (Islamic law) and prohibits in dealing with interest. It is defined as “banking or banking activity that is consistent with the principles of Islamic law (Sharia) and its practical application through the development of Islamic economics. Sharia prohibits the fixed or floating payment or acceptance of specific interest or fees (known as Ribaa or usury) for loans of money. Investing in businesses that provide goods or services considered contrary to Islamic principles is also Haraam (forbidden).”[1]

The terminologies may be divided into three parts: financing, leasing and investing.

2.1.2 Investment

Mudaaraba: This involves two parties starting a partnership where one gives the money and the other provides the expertise and other resources such as time. Profits are shared in a predetermined proportion however any losses which occur are the responsibility of the bank.

Mushaaraka: Mushaaraka is partnership. Here, capital is shared between more than one parties and therefore risk and reward are also shared. The difference between Mushaaraka arrangements and conventional banking is that the business partner can set any type of profit sharing ratio, but losses must be proportionate to the amount invested. Under this arrangement a bank joins a commercial enterprise in founding a joint venture, where they partake in predetermined proportions. Both profits and losses are shared in a prearranged manner.

Muraabaha: This is a contract for purchase and resale and permits the customer to make purchases without having to take out a loan and pay interest. For example, a bank purchases a car for the customer, and re-sells it to the customer on a deferred basis, adding an agreed profit margin. The customer then pays the sale price for the car over installments, thus obtaining credit without paying interest.

2.1.3 Financing

 Muraabaha: This is referred as a contract for purchase and resale and allows the consumer to make purchases without having to apply for loan and give interest. For example, the bank purchases the goods for the customer, and re-sells them to the customer on a deferred basis, adding an agreed profit margin (called mark-up). The customer then pays the sale price for the goods over installments, effectively obtaining credit without paying interest.

Qard hasanah: This is when we have a loan without interest. Only the amount that is borrowed is paid back. He/she may pay an additional amount at his absolute judgment as a symbol of appreciation. An Islamic bank can use this as a current account, allowing customers to keep money (or receive payment, or carry out any type of money transfer) in the bank without earning interest.

Ijaara: Ijaara means lease or rent. It involves a contract where the bank buys and then leases an item – perhaps a consumer durable, for example – to a customer for a specified rental over a specific period. The duration of the lease, as well as the basis for rental, are set and agreed in advance. The bank retains ownership of the item throughout the arrangement and may take back the item at the end.

Istisnaa’: This is a contractual agreement for manufacturing goods and commodities. It facilitates advance cash payment and future delivery or a future payment, and future delivery. Istisnaa’ can be used for providing the facility of financing the manufacture or construction of houses, plants, projects, and building of bridges, roads, and highways etc.

2.1.4 Islamic insurance

 Takaaful: Takaaful can be claimed to be Islamic insurance. Here, the majority guarantees the loss of the minority (i.e. the majority shares the burden of the unfortunate minority through the accumulation of funds). It is one kind of co-operative insurance. Takaaful is a substitute form of cover that a Muslim can use against the jeopardy of loss due to misfortunes.

Wadiah: In this arrangement of safekeeping, bank is assumed as a keeper and trustee of funds. A client deposits funds in the bank and the bank promises refund of the entire sum of the deposit, or any part of the outstanding amount, whenever the depositor asks for it.

2.2 Banking in The Light of Holly Quran and Hadith:

Transactions that deal in interest are unlawful in Islam; banking that involves interest is strictly forbidden. Many of the conventional banking laws are shunned upon in the light of Islam. There are several verses in the holy Quran and authentic Hadith that reflects this.

“Those who feed on usury will only rise again (on the last day), like those possessed by the devil. They say in effect, usury and selling is the same thing, whereas God permits selling but forbids usury… God will reduce interest to dust while making alms fruitful…O you believers, fear God, and renounce the excess of usurious interest, if you really believe. If you do not follow this ruling, you may expect the hostility of God and of his Messenger. If you repent, you will retain your capital, neither harming anyone else nor suffering harm yourselves. To a debtor in difficulty, grant a delay until his situation improves. And if you renounce your rights that will be better still.” [Quran 2:275-280]

2.3 Not just in the Holy Quran prohibition of interest is also mentioned in the Hadith:

The Messenger of Allah (pbuh) said, “Gold for gold, silver for silver, wheat for wheat, barley for barley, dates for dates, and salt for salt; like for like, hand to hand, in equal amounts; and any increase is Ribaa.” [Muslim]

While the above says that “the increase is Ribaa”, the following quotation says who is sinful in the whole process of dealing with interest:

 He (pbuh) cursed the one who takes Ribaa, the one who pays it, the one who witnesses it, and the one who documents it. He then said, “They are all equal (in sin).” [Muslim]

Hence, a “good” Muslim strives to avoid conventional banking. Dealing in the conventional banking system is therefore unlawful in Islam.

 2.4 Privileges of Islamic banking

The biggest privilege: and the most important- a Muslim earns from avoiding conventional banking system and using Islamic banking and of course, his reward in the life hereafter. However, he also gets many financial benefits in the worlds too:

In Islamic banking, the burden is not thrown to the entrepreneur. Rather, it becomes a profit sharing project. This process is very fair and just compared to when the bank, even though gives its own money, is not liable for any loss.

“One of the unique and salient characteristics of Islamic banks is that the integration of ethical and moral values with its banking operation. The ethical and moral consideration of Islamic banks cannot be detached and their behavior should be consistent with the moral and ethical standards laid down by the Islamic Shari’ah.

Unlike the conventional banks, the financing of Islamic banks are restricted to useful goods and services and refrain from financing alcoholic beverages and tobacco or morally unacceptable services such as casinos and pornography, irrespective of whether or not such goods and services are legal or not in a given country.”[2]

“Another important characteristic which forms the basis for the development of Islamic banks is the relationship with depositors. They deal with their customers on investment grounds rather than a pre-determined fixed interest rate. They invest the money of their depositors on high profitable projects after going through a strategic analysis in order to give a substantial return to their depositors.

Thus in Islamic banking industry, each bank will attempt to out-perform other banks if it wants to attract funds from investors. And the ultimate result is that a high return on investments for the investors, which is unlikely in a conventional bank where it deals with their depositors on a pre-determined fixed interest rate.

Furthermore Islamic banks eliminate the barrier between those who save and those who invest, and bring them closer to the real market. The nature of the financial intermediation of Islamic banks significantly defers from conventional banks and it is in harmony with real market and developmental changes in it.”[3]


Evolution and current condition of Islamic Banking

3.1 Evolution, development and current condition of Islamic Banking:

Recent years have seen the rise of Islamic banking worldwide. The origin of proper Islamic banking doesn’t go very far away. “First instance of Islamic banking came into the picture in Egypt in 1963. The pioneering efforts by Ahmad El Najjar brought this bank into existence, whose key principle was profit sharing (non-interest based philosophy of Shariah). By the end of 1976 there were 9 such banks in the country. These banks neither charged nor paid interest but their activities were mostly limited to trade and industries where these banks invested directly or as partners of depositors. Hence, functionally these banks were working more as financial institutions rather commercial banks.”

The real boom in Islamic banking occurred in 1980s. Earlier, Islamic banking only focused on interest-free banking; it didn’t cover other major issues such as property rights etc which falls under this kind of banking system. “The new, wider spectrum of Islamic finance covers not only banking activities but also capital markets, capital formation and other financial instruments and intermediaries.” [4]

Today, Islamic banking is not just found in Islamic countries, but are popular in secular states as well as in those country where the majority is non-Muslims.

 Assets that conform under Islamic law reached about $400 billion across the globe in 2009, (with Iran, Malaysia and Saudi Arabia being the major contributors) according to Standard & Poor’s Ratings Services, and the potential market is $4 trillion.

“In 2009 Iranian banks accounted for about 40 percent of total assets of the world’s top 100 Islamic banks. Bank Melli Iran, with assets of $45.5 billion came first, followed by Saudi Arabia’s Al Rajhi Bank, Bank Mellat with $39.7 billion and Bank Saderat Iran with $39.3 billion. Iran holds the world’s largest level of Islamic finance assets valued at $235.3bn which is more than double the next country in the ranking with $92bn. Six out of ten top Islamic banks in the world are Iranian. In November 2010, The Banker published its latest authoritative list of the Top 500 Islamic Finance Institutions with Iran topping the list. Seven out of ten top Islamic banks in the world are Iranian according to the list.” wikipedia

3.1.1 Development of Islamic banking in Malaysia

 The long-term objective of the Central Bank of Malaysia was to create an Islamic banking system operate parallel to the conventional banking system. A single Islamic bank (BIMB) did not represent the whole financial system. It required large number of pro-active players, wide range of products and innovative instruments, and a vibrant Islamic money market. Realizing the situation, the Central Bank introduced Interest Free Banking Scheme (now replaced with Islamic banking scheme (IBS) in March 1993. The scheme allowed conventional banking institutions to offer Islamic banking products and services using their existing infrastructure, including staff and branches. Since then, the numbers of IBS banking institutions have increased to 36 till the end of 2003, comprising 14 commercial banks (of which 4 are foreign banks), 10 finance companies, 5 merchant banks and 7 discount houses. The Central bank of Malaysia in its annual report (1993, page no 57) stated:

“With the implementation of the interest free banking scheme, Malaysia has emerged as the first country to implement a dual banking system, whereby an Islamic banking system functions on a parallel basis with the conventional banking system”.

 The aspiration to establish a comprehensive Islamic financial system has created a spill-over effect to the non-bank Islamic financial intermediaries which also started to offer Islamic financial products and services under Islamic banking scheme. Such institutions include the Takaful Companies, the savings institutions (i.e. Bank Simpanan Nasional & Bank Rakyat) and the developmental financial institutions (i.e. Bank Pembangunan dan Infrastruktur Malaysia and Bank Pertanian.

In October 1996, the Central Bank issued a model financial statement for the IBS banks requiring them to disclose their Islamic banking operations (balance sheet and profit and loss account) as an additional item under the Notes to the Accounts. The Central Bank also setup a National Shariah Advisory Council on Islamic Banking and Takaful (NSAC) on 1 May 1997. The council considers as the highest Shariah authority on Islamic banking and Takaful businesses in Malaysia. On 1 October 1999, the Central Bank issued license for second Islamic bank, Bank Muamalat Malaysia Berhad.

The country also introduced Islamic debt securities market has made its debut in 1990 with the issuance of RM 125 million Islamic bonds. Islamic Inter-bank Money Market (IIMM) on 4 January 1994 to link institutions and Islamic investment based instruments. Since then, both the markets provide variety of securities ranging from two to five years medium terms Islamic bonds to short-term commercial papers one to twelve months. 

3.1.2 Present scenario of Present scenario of  Islamic Banking System in Pakistan:

Pakistan after the gap of twenty years has now decided to shift towards interest free economy in a gradual and phased manner without causing any further disruptions[3]. Some extracts from the affidavit submitted by the Deputy Governor of the State Bank of Pakistan (SBP) in the Supreme Court of Pakistan reflected the future policy of the Bank for the time being.

That having taken a series of steps to promote Islamic banking………. and considering all other practical problems associated with the complete transformation of the financial system, discussed herein, it is State Bank of Pakistan’s considered judgment that the parallel approach will be in the best interest of the country. This means that Islamic banking is introduced as a parallel system, of which beginning has already been made; it is provided a level playing field vis-à-vis the existing conventional banks, and its further growth and development is supported by Government and State Bank of Pakistan through appropriate actions. The approach will eliminate the risk of any major cost/damage to the economy, give a fair chance to Islamic banks to develop alongside the conventional banks, and will provide a choice to the people of Pakistan, and the foreigners doing businesses in/with Pakistan, to use either of the two systems”[4].



4.1 Conclusion:

 Earning, paying, witnessing or dealing with interest is strictly forbidden under Islamic law. Even a few decades ago Islamic banking did not provide the comfort and sophistication conventional banking provided. However, the past decade or so has seen a rise in Islamic banking, thus making the whole process of Islamic banking more available and affordable. It is indeed good news for the Muslim community worldwide that Islamic banking has gained popularity in recent times. The rise of Islamic finance is part of a larger phenomenon of a global Muslim renewal that has occurred over recent decades. Theoretical studies of Islamic finance have demonstrated the ways in which contract forms deemed theologically permissible to Muslim scholars can be applied to modern financial practices. Likewise, studies of Islamic financial systems have described how Islamic finance works in practice, and identified the ways in which various national systems differ from one another. Almost entirely omitted from this literature is the focused study of what determines individual use of Islamic financial products. This paper begins to fill this gap in the literature.

Considering the use of Islamic financial products as a claim about identity rather than merely a consequence of one’s piety or religiosity encourages analysts to look beyond religion to other factors that may influence individuals’ strategies for identity maintenance. Focusing on Indonesia—where conventional and Islamic financial systems coexist, where expressed piety is on the rise, and where Muslims face the social changes inherent in modernization and globalization—we discover that piety is far less important as a factor in shaping individuals’ use of Islamic financial products than the narrow marketing literature would suggest. Instead of, modernization and globalization themselves appear to play the decisive roles in shaping individual use of Islamic financial products. The picture that my empirical results paint is static, focusing on a snapshot of contemporary Indonesia rather than on the processes through which class formation and global identity formation promote the use of Islamic financial products. But the cross-sectional variation that I identify among Indonesian with regard to their individual use of Islamic financial products is nevertheless informative, and it is consistent with the view that modernization and globalization rather than religious change itself are the factors driving the rise of Islamic finance.

These findings give new context to research on modernization, globalization, and identity of the Muslim world by exploring an important but understudied component of Muslims’ daily lives. Far from being irrelevant or inconsequential due the fact that it so closely parallels conventional finance, Islamic finance is a uniquely powerful symbol of identity politics in the Muslim world precisely because it is so nearly indistinguishable from conventional finance. The choice of Islamic financial products—at least in plural banking systems such as those found in Indonesia—is therefore a window into the ways in which social and economic changes are filtered through religion to yield concrete changes in the lives for millions of Muslims.


  1. Abduh, Muhamad, and Mohd Azmi Omar. 2007. “Who Patronizes Islamic Banks in Indonesia?”.
  2. Abdul Rahim, Abdul Wahab, Mervyn K. Lewis, and Hassan M. Kabir. 2007. “Islamic Takaful: Business Models, Shariah Concerns, and Proposed Solutions.” Thunderbird International Business Review 49(3): 371-96.
  3. Aggarwal, Rajesh K., and Tarik Yousef. 2000. “Islamic Banks and Investment Financing.” Journal of Money, Credit, and Banking 32(1): 93-120.
  4. Ariff, Mohamed. 1988. “Islamic Banking.” Asian-Pacific Economic Literature 2(2): 48-64.
  5. Asyraf, Wajdi Dusuki, and Irwani Abdullah Nurdianawati. 2007. “Why do Malaysian Customers Patronise Islamic Banks?” International Journal of Bank Marketing 25(3): 142-60.
  6.  Bank Indonesia. 2008. “Akselerasi Perbankan Syariah.” & “Statistik Perbankan Indonesia Juli 2010.”
  7. Bank Muamalat. 2010. “NISBAH & TARIF.”
  8. Chamberlain, Gary. 1984. “Panel Data.” In Handbook of Econometrics. Volume 2, ed. Zvi Griliches and Michael D. Intriligator. Amsterdam: Elsevier. 1247-318.
  9.  Clarke, Janine A. 2004. Islam, Charity, and Activism: Middle-Class Networks and Social Welfare in Egypt, Jordan, and Yemen. Bloomington: Indiana University Press.
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  14. http://sundaytimes.lk/080120/FinancialTimes/ft337.html
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  16. http://shariah-fortune.com/history-of-islamic-banking
  17. 17.  http:// lawyersnjurists.com

Interestingly, mudarabah profit-sharing contracts are commonly used by Islamic banks to offer “interest”-bearing deposit accounts (Zubair 2002). Here, the depositor is the lender and the bank is the borrower, and the bank agrees to share its profits with its depositors rather than paying interest (although the profits are disbursed regularly and are advertised as a percentage of the deposit, much like interest). Strictly speaking the bank is not required to pay profits, and in some cases the bank does not guarantee the deposit.

The decision was made in a meeting held on September 4, 2001 under the Chairmanship of the President of Pakistan attended by the officials of the Ministries of Finance and Law, Governor State Bank of Pakistan, Chairman and some members of the Council of Islamic Ideology and the Chairman of the CTFS. (Reference, State Bank of Pakistan, Annual Report, 2003, page no 193).

[3] The State Bank of Pakistan, Annual Report (2003), PP 194-195.