Evolution of the Concept & Practices: Islamic Banking

A question which may legitimately be asked by any observer of Islamic banking is: the Islamic injunction against riba is at least 1400 years old while Islamic banks have emerged on the scene only 15 years ago in the middle of 1970s. Why the Islamic world took so long to come up with an alternative to interest-based banking?

The answer is necessarily based on historical factors. The history of commercial banks in the western world itself is not very old. Development of commercial banking in the West has synchronised with the emergence of industrial civilisation in the last two and a quarter centuries. With the industrial revolution, there was a tremendous expansion in the number of traders, manufacturers, industrialists and other entrepreneurs who wanted to expand their businesses and set up various kinds of firms but their own financial resources were not enough for it. Hence, a method was to be found which would give finance users access to the finances of others.

Thus, the needs of financial intermediation gave birth to commercial banking which very soon became the backbone of modem industrial and financial system. An efficient and smoothly functioning banking system is today one of most basic prerequisites for having an efficient economic organisation. However, all these happened within the backdrop of western cultural tradition which had shrugged off the moral and ethical considerations of Christianity from economic and business relations in its early stages of development.

When the Muslim world, in the early 19th century', as a result of western imperialism and colonialism, came into contact with the industrialisation and other associated institutions of capitalism including the commercial banking system, Muslims had any one of two choices:

1. Accept the institution of commercial banking as it is and argue that interest charged by the commercial banks docs not contain the elements of riba prohibited by Islam. Hence, commercial banking would become permissible and Muslims would have no reservation against it.
2. Accept the verdict that interest charged by commercial banks is riba and, in view of indispensability of commercial banking, made an attempt to develop an alternative system of banking which would not violate any tenets of the Islamic Shari'ah.

During the middle of the 19th century, several ulema (religious scholars) in Egypt, Indian subcontinent, Indonesia and in other Islamic lands made an attempt to take the first position. This was a period when the Muslim world, after suffering through colonialistic domination, was on the retreat and Muslim intelligentsia had developed a defeatist mentality. There was a tendency to rationalise all fads coming from the West. Hence, it was not surprising to see that some attempts, albeit unsuccessful, were undertaken to dilute the strong in- junctions against riba. It was argued that riba condemned and prohibited by the Qur’an is really usury and not the interest which is the basis of functioning of modem banks. It was also held that its prohibition is mainly aimed at eliminating the excesses and exploitation involved in the consumption loans when given on interest. Since commercial banks give loans mostly for productive purposes, prohibition of riba may not cover the bank loans. The advocates of these views neglected the fact that Qur’an categorically declares any surplus (or excess) over the principal amount as riba and clearly mentions that creditors are entitled only to their principal amounts. It was also forgotten that Islam docs not make any distinction between the consumption loans and productive loans. The prohibition of riba has to apply irrespective of the purpose for which loans have been raised.

However, it is also a historical fact that these views were held by a minuscule minority in the Muslim countries and did not cut much ice either with the majority of Muslim scholars or ordinary believers who had serious reservations about the correctness of these positions and permissibility of bank interest.

As a consequence, modem commercial banking could not make much headway in the Muslim countries the way it did in the western world and even in some Asian countries. This is corroborated by the fact that commercial banking in the Muslim world is mainly confined, even today, to large urban centers where western culture and civilisation has made deep inroads. Even in the cities, a significant number of population stays away from the commercial banks for religious and moral reasons respecting the injunctions against riba. Even among those who have to deal with the banks, under the force of circumstances, or due to nonavailability of any Islamically permissible banking facility, there is a large number of people who believe it to be a violation of faith. Consequently, they do not make any use of interest earned by their funds. Either they leave it at the bank unclaimed, or give it to someone else.

The other approach of evolving a banking system consis- tent with the requirements of Shari‘ah has become lately more important although the idea to establish an interest-free bank dates back to as early as 1940s. The conditions, however, then were not ripe enough for actual establishment of an Islamic bank as not much thought had been given to technical details and actual operation of an interest-free bank. In fact, in the absence of any breakthrough in theory of interest- free banking, the idea of interest-free banking remained only a desire, not even a blueprint, for a long time.

In 1952, when the Saudi Arabian Monetary Agency (SAMA) was created by a royal decree to function as a central bank in Saudi Arabia, it was not pcnniltcd to pay or receive any interest.9 Probably, this was for the first lime that prohibition against interest was figured in an official document of any Muslim country in the modem times. Although, SAMA’s charter has been modified several limes since then, “the SAMA or other government bodies, however, cannot legally accept interest on money they lend.” Nevertheless, SAMA being a central bank could not perform the usual commercial banking function in an interest-free framework.

Source: Elimination of Riba, Khurshid Ahmad, Khalid Rahman and Zahed A. Valie. Republished with permission.