The History of Islamic Banking

Financial institutions became a nucleus in a development of neo-economical societies. The richer started to give loan to the needy groups in continuing their daily life. The needy groups will work hard to get the income and paying back the richer with certain additional amounts on top of the original amount borrowed. Failure to do that will result in a repossession of any material owned by the needy groups or to impose a higher interest which was impossible for them to repay. As a result a loaner will become richer and richer and a needy will become poorer and poorer. The situation became worst when the richer set up an institution called as ‘banking institutions’ in legalizing the mentioned activities.

From the above discussion, it seems that the existing financial institutions are corrupted and not in line with Islamic objectivity for example to help each other, unity and to avoid disunity. Allah SWT mentioned this in a few verses in Al-Quran for example:-

(1) واعتصموا بحبل الله جميعا ولا تفرقوا (ال عمران: 103)
“Grab hold of the rope of Allah collectively and do nor disunite”

(2)(الأنفال) وأطيعوا الله ورسوله ولا تنازعوا فتفشلوا وتذهب ريحكم واصبروا إن الله مع الصابرين
“And obey Allah and His Messenger and do not dispute with one another, lest you falter and your strength will depart from you and be steadfast: indeed Allah is with the steadfast”

(3) تعاونوا علي البر والتقوي ولا تعاونوا علي الإثم والعدوان (المائدة : 2)
“Cooperate with one another unto righteousness and ‘taqwa’ and do not co-operate with one another unto unrighteousness and enmity”

The above verses and many others order human beings to work hard toward social unity and cohesion, construct their societies based on unity and preserve and defend that unity. Unity and social cohesion is so central among the objectives of the Quran for mankind that it can be argued that all conducts prohibited by Islam are those that ultimately will lead to social disintegration. And, conversely, all righteous conducts prescribed by Islam are those that lead to social integration, cohesiveness and unity (Mirakhor, 1995). In order to rectify the problem of financial institutions, Islam in general has provided the solution.

In Islam, the informal financial system has being implemented since the beginning of Islamic history. The system was used to organize resources, finance productive activities and meet consumer needs. This system has proven to be quite effective during the development of Islamic civilization (Abdelhamid, 2005). The fundamental reference of this system is coming from Al-Quran, As-Sunnah, Ijma and Qiyas.

However as the time goes on and the economic activity shifted from Middle Eastern centric to western world, the features of Islamic finance remained un-developed while Western financial institutions prevailed. (Mirakhor, 1995)

Historically, the first Islamic bank was found in Pakistan in the 1950s. It was developed confidence of the ummah at the first attempt but failed to continue in a long period because of the operational failure not the system. The second attempt in establishing the Islamic Banking was held in Egypt, by Ahmed El Najjar in Mit-Ghamr. This institution did not emphasize on its Islamic image in order to avoid conflicts with the existing secular government. However, towards the end of this experiment in 1967, there were nine similar banks established in Egypt (Mirakhor, 1995). In 1963 in Malaysia, another Islamic Financial Institution was created with the name of Muslim Pilgrims Saving Corporation. This institution was responsible to assist people in saving for the Hajj (Pilgrimage) to Mecca, Saudi Arabia. A lot of evolvement occurred to this institution until now and the successful of it led to the establishment of Bank Islam Malaysia Berhad (BIMB), the first Islamic bank in Malaysia.

In the 1970s, a few major events took place acting as pillars for the continuation of Islamic financial systems (Mirakhor, 1995). First is the creation of Islamic Development Bank, the bank that created by Muslim countries from all over the world to support the economic development of Muslim nations whilst complying with Islamic law (Mirakhor, 1995). Other Islamic financial institutions set up at that time were the Faisal Islamic Bank of Sudan, Faisal Islamic Bank of Egypt and the Islamic Finance House in Luxembourg.