LS5306 ISLAMIC BANKING AND TAKAFUL

HISTORY AND DEVELOPMENT OF ISLAMIC BANKING SYSTEM

INTRODUCTION

• Islamic banking refers to a system of banking or banking activity that is consistent with the principles of the
Shari'ah (Islamic rulings) and its practical application through the development of Islamic economics.

• The underlying principles that govern Islamic banking are mutual risk and profit sharing between parties, the
assurance of fairness for all and that transactions are based on an underlying business activity or asset.
• It aims to eliminate exploitation and to establish a just society by the application of the Shari'ah or Islamic rulings
to the operations of banks and other financial institutions.

1. Interest-based
2. The functions and operating modes of conventional banks are based on fully
manmade principles.
CONVENTIONAL
BANKING 3. The investor is assured of a predetermined rate of interest.
4. It aims at maximizing profit without any restriction.
5. It does not deal with Zakat.

1. Prohibition of interest rate

2. The functions and operating modes of Islamic banks are based on the principles of
Islamic Shariah
3. Promotes risk sharing between provider of capital (investor) and the user of funds
ISLAMIC
(entrepreneur)
BANKING
4. It also aims at maximizing profit but subject to shariah restrictions
5. In the modern Islamic banking system, it has become one of the service-oriented
functions of the Islamic banks to be a zakat collection centre and they also pay out their
zakat.

• The objective of welfare and justice Islamic goals in its dealing with persons or institutions is to consider them as
partners and thus were profit is made it is shared equitably between them and were losses are incurred it is shared
together.
• Unlike conventional banks, basic principle of operation is to maximise profit and thus, it does not seek to be
welfare and justice oriented and it consider those who borrow from them not as partners but creditors. Any loss
incurred is at the expense of these who received the advances from them

HISTORICAL DEVELOPMENT OF ISLAMIC BANKING

• From the historical point of view, Islamic banking can be divided into 3 eras:

1. Pre-Islamic era
ERA 2. Islamic era
3. Modern Islamic era

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PRE-ISLAMIC ERA

• Before the coming of Islam, banking activities has begun in the Arab but its operation has the element
of riba. Meccan of that time used the money either giving it to another party to be traded through al-
Qirad or mudarabah and the profits is share by both party or lending the money to gain benefits which
consider as riba (Mohammad & et. al, 2013).
• However, the coming of Islam has resulted in complete prohibition of all activities that involve riba,
and this prohibition did not prevent the development of trade that took place either nationally or
internationally and the origin of Islamic finance dates back to the dawn of Islam 1,400 years ago.
• Prophet Muhammad before the time of his prophet hood had applied the concept of trust. Due to his
noble conducts such as honesty and integrity, the Arabs of his had appointed him as their wealth keeper.
• Apart from that, during the time of the Prophet there was also a man by the name al-Zubayr alAwwam
who took the role as a bank, and kept the deposits for other people.
• However, this form of money keeping was modified by him to loans. Abd Allah bin Al-Zubayr, the son
of Al- Zubayr narrated that when people brought their money to be kept by his father, he will tell that
person that the money is being borrowed, instead of being deposited, as his father was worried that he
might lose the money.
• Al-Zubayr’s action resulted in two main objectives;

1. The first is by taking the deposit as loans, he has the right to use the money.
2 OBJECTIVES 2. If the deposit is not used, the owner will experience loss; so, if it is regarded
as a loan, it is safer as the borrower is responsible in returning the money

• Other than that, there were evidences that the development of Islamic banking foundation had started
since the time of the Prophet. Among these foundations was the development of Bayt al Mal, which
was the central bank for Islamic countries and played a role in aiding the poor, especially the Muslims.
• Furthermore, there is clear broad structure of principles practice by Prophet Muhammad (p.b.u.h) for
example contract of mudarabah between Khadijah and Prophet (p.b.u.h), musyarakah whereby Al-Sa'ib
Ibn Abi Al-Sa'ib became a partner of the Prophet (p.b.u.h.) before his prophethood, bay’ al-salam was
practiced in the agricultural sector of Madinah during the time of the Prophet (p.b.u.h.) and benevolent
loans (qard hasan) which is another form of financing were also encouraged during that time.

ISLAMIC ERA
• The beginnings of Islamic banking, in its wider sense, date back to the early days of Islam and the rise
of the Islamic Empire. The boom in the internal and external trades in the dawn of Islam led to the
creation of Islamic financial tools such as deposits, money transfers, checks, bills of exchange, and so
forth to cope with these commercial developments.
• Later, the Europeans adopted these Muslim practices and continued to evolve them until modern days.
In Islamic countries, Islamic financial practices withered gradually due to the weakening of the Islamic
empire, until these practices were replaced by the Western financial model in the early 16th century.
However, Islamic financial practices emerged again in the middle of 19th century

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• The practices of Islamic banking are usually traced back to businesspeople in the Middle East who
started engaging in financial transactions with their European counterparts during the Medieval era.
• At first, they used the same financial principles as the Europeans. However, over time, as trading
systems developed and European countries started establishing local branches of their banks in the
Middle East, some of these banks adopted the local customs of the region where they were newly
established, primarily no-interest financial systems that worked on a profit-and-loss sharing method.
• By adopting these practices, these European banks could also serve the needs of local businesspeople
who were Muslim.

HISTORY OF ISLAMIC BANKING MODERN ERA

• Western commercial banks date from about two and a quarter centuries ago, when the western world
was dispensing with moral and ethical considerations in economics.
• When the Muslim world came into contact with the west, Muslims had two choose:

a) To accept commercial banking, arguing that the interest charged by them

did not contain the element of riba.
OPTION
b) To accept that interest charged was riba and try to develop an alternative
system of banking.

• The late 19th and early 20th century is widely known as the beginning of the era of Islamic resurgence.
• Some of those responsible for this resurgence are Muhammad Abduh (1849), Rashid Reda (1865),
Muhammad Iqbal (1975), Abul Aala Maudud (1937), Hasan AlBanna (1939), Hifz Al-Rahman (1942),
Muhammad Hamidullah (1944), Anwar Qureshi (1946), Naiem Siddiqi (1948), Mohammad Yousuf
Al-Dean (1950) and Muhammad Uzair (1955).
• Their thoughts became the impetus for Muslims to apply Islamic teachings in all aspects of life
including political, social and economic. Since Islam prohibits riba, it is obvious that elimination of
riba from the economic and banking system became the most popular topic among contemporary
Islamic scholars
• Thus, in the1960s, Muslim thinkers began to explore ways and means of organizing commercial
banking on an interest-free basis and since 1975, many new interest-free banks have opened.
• The first attempt at Islamic banking system can be seen in Malaysia in the mid-1940s and Pakistan in
the late 1950s.
• The objective of this institution setup by Malaysia was to invest prospective pilgrim savings in the real
estate and plantations in accordance with Shariah but it was unsuccessful.
• While, Pakistan establishment of Local Islamic Bank in the rural area. During that time, the owners of
the land who were obedient to the Islamic teachings deposited their money to the bank, which was later
loaned to other landowners for the purpose of agriculture development. The borrowers during that time
were not charged for lateness in paying back their loans, other than a small amount for the purpose of
bank operation.

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• However, the operation of the bank was met with failure due to a number of factors such as the increase
in the number of borrowers compared to the money being kept there, which resulted in vast difference
between available capital and credit demanded, as well as the problem of the bank employees not having
autonomous power on the bank operation. This was because the depositors of that time were hoping to
get more benefits as a return for the money that they lent.
• The second attempt was through setting of banking basic principle and Islamic finance that are to be
practiced. The endeavor took place in Egypt from 1963 until 1967 through the establishment of Mit
Ghamr Savings Bank in the town of Mit Ghamr led by Ahmad El Najjar, in the area of the Nile River
Delta, which is 40 kilometers from Cairo.
• Its functioned essentially as saving- investment institutions rather than as commercial banks. Although
the services are considered basic banking services, it was nevertheless sufficient to meet the banking
needs of the surrounding community. However, the existence of the bank was shortlived. The whole
operation of Mit Ghamr Bank was taken over by the National Bank of Egypt and Egypt Central Bank
in mid-1967, which changed the whole bank operation to the riba system.
• But, the establishment of Mit Ghamr Saving Bank marked a new milestone in the revolution of the
modern Islamic banking system. This bank was considered to be the most innovative and successful
experiment with interest-free banking.
• After Mit Ghamr converted into conventional system, the Nasir Social Bank was established in Egypt
in l97l and declared as an interest-free commercial bank, although its charter made no reference to
Islam or Shariah.
• In 1974, the finance ministers of all Islamic countries held a convention on the establishment of the
Islamic Development Bank (IDB). IDB was considered to be the first international Islamic bank that
was established with the founding member of 22 Islamic countries.
• The bank’s principal office was located in Jeddah, Saudi Arabia and has two regional offices in Rabat,
Moroco and Kuala Lumpur, Malaysia. The purpose of the bank is to foster the economic development
and social progress of member countries (OIC) and Muslim communities individually as well as jointly
in accordance with the principles of shariah. This was a landmark in the history of Islamic banking
• The need to establish an Islamic banking system reach its peak around 1970’s
• The action was taken by private initiatives rather than the government.
• King Faisal bin Abdul Aziz al-Saud (The late Saudi Arabian King) establish the organization of Islamic
Countries (OIC) and urged Muslim countries to set up their own Islamic Banking System.
• The establishment of IDB 1974 paved the way for the establishment of other Islamic banks in various
Muslim countries. Throughout the 1970’s, a number of Islamic banks were founded, mostly in the Arab
Middle East. Immediately after the establishment of IDB in 1974, the Dubai Islamic Bank was
incorporated. In the year 1977, three more Islamic Banks commenced business for example Faisal
Islamic Bank of Egypt, Faisal Islamic Bank of Sudan, Kuwait Finance House and Bahrain Islamic Bank
in year 1979.
• While throughout the 1980’s, several Islamic Institutions has established for example Qatar Islamic
bank, Islamic bank Bangladesh limited, Bank Islam Malaysia Berhad, Al-Baraka Islamic Bank of
Bahrain, ANZ Global Islamic Finance of UK and among others.

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• Some countries including Pakistan, Iran, Sudan, Malaysia and Bahrain initiated efforts to implement
Islamic banking at larger scales in their respective countries during 1980s. In the next decade some of
the conventional banks also introduced Islamic banking products and services by operating separate
Islamic banking units and divisions

ISLAMIC BANKING IN BRUNEI

• Islamic Finance in Brunei Darussalam has been implemented since 1992 with the establishment of
Perbadanan Tabung Amanah Islam Brunei (TAIB) regulated under the TAIB Act (Chapter 163). This
is then followed by the incorporation of Islamic Banks pursuant to the Islamic Banking Act (Chapter
168), which saw the establishment of The Islamic Bank of Brunei Berhad (1993) and The Islamic
Development Bank of Brunei Berhad (2000).

➢ The Development Bank (July 1980)-first conventional bank in Brunei

➢ The International Bank of Brunei (1986)
ISLAMIC
BANKING IN ➢ Islamic Bank of Brunei-(IBB) 1993
BRUNEI
➢ Islamic Development Bank of Brunei (IDBB)2000
➢ IBB + IDBB = BIBD (2006)

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