Islamic Banking and Finance Infrastructure Institutions

Published: Last Edited:

This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.

Islamic Banking and Finance Infrastructure Institutions

Write about the existing infrastructure institutions (AAOIFI, IIRA, IIFM etc.) Explain their roles for the Islamic banking industry? Have they contributed to the growth and evolution of Islamic banking? Are these institutions all efficiently utilized by the Islamic banks? What are the prospects of their growth? Is there anything else demanded?

An initial market economy and an initial form of mercantilism, called Islamic capitalism, were created between the 18th and 12th centuries. The monetary economy of the era was depending on the largely circulated currency the gold dinar and it hold together regions that were in the past economically independent. A number of economic images and techniques were used in initial Islamic banking, including exchange bills. Partnership (which also include limited partnerships), and forms of capital (al-mal), capital accumulation (nama al-mal), bank cheque, promissory notes, trusts, transactional accounts, loaning, ledgers and assignments. Organizations free from the state also existed in the medieval Islamic world, while the agency institution was also started during that period. Many of these initial capitalist images were used and further advanced in Europe form the 13th century onwards.

In the 20thcentury, scholars,NaeemSiddiqi ,MaulanaMaudui and Muhammad Hamidullah, All noticed and identify the demand for commercial banks and their perceived “ necessary evil”, and purposed a banking system based on the image of Mudarabha –which is defined as a relationship in which one contributes capital and the other partner contributes expertise to earn profit and sharing the profit at the basis of 50:50 ratio or half/half. The investor is called RabulMaal and the other partner is termed as mudarib. As more works specifically focused to the subject of interest – free banking were authored by Muhammad Uzair (1955), Abdullah al-Araby (1967), Nejatullah Siddiqi (1961-1969), al Najjar(1971) and BaqiralSadr ( 1961,1974).

The roots of Islamic banking can be found back to the arrival of Islam when the Prophet PBUH himself done trading of clothes for his beloved wife Hazrat Khatija R.A. In the mid of the 20th century some organizations were following the financial services that comply with Islamic laws. The initial, experimental, local Islamic bank was made in the late 1950s in a rural area of Pakistan in which no interest was charged from the customer on its granting. It was a great effort, in sharia compliant savings banking was undertaken in 1963 in rural Egypt by person named Ahmad Elnaggar, he was an economist by profession .The bank attracted people who lack confidence in banks which are run by the state. The profit-sharing experiment, in the town of MitGhamr, did not specify as advertise its Islamic nature for fear of being seen as a demonstration of Islamic principles that was anathema to the Gamal Nasser regime. The government closed the experiment in 1968, but it was considered by many people a success. At this time currently there were nine such banks in the country. In 1972, the MitGhamr Savings project becomes part of Nasr Social Bank which, today is still in business in Egypt.

The Islamic system of banking depends on five major principles, namely Qardhassan, means good loan or benevolent loan, takaful means Islamic insurance, Sukuk means Islamic bonds, wadiah means safekeeping and wakala means power of attorney. These rules are similar to the banking system the only difference is that they follow the Islamic laws which is the sharia law .

By 1995, 144 Islamic financial institutions had been created around the world, which include 33 government banks, 40 private banks and 71 investment association or group. The combination of institutions, governments, and different conferences and research on Islamic banking were instrumental in applying the application of theory to practice for the initial banks without interest.

As it is now a fast growing industry it is expected that by 2008 Islamic banking rate of growth of was10-15% per year and with symbols of future growth. Islamic banking system have more than 300 institutions allover 51 countries around the globe, it also includes big countries like the United States through association or group such as the Michigan based University bank, as well as an additional 250 mutual funds that also follow the Islamic principles. It is estimated that over US$822 billion worldwide sharia-compliant assets are managed according to Economist. This represents approx. 0.5% of total world estimated assets as of 2005.

Islamic banking is gaining acceptance now all over the world, especially in fast growing and emerging markets, as an effective means to make an inclusive financial system which can replace the shadow economy which is used in the past.

Key matters that are in conflict with Islamic banking business in emerging markets areas following:

  • In process rebalancing of the economy of the world and eastward shift of trade and GDP growth
  • Major review of financial regulations.
  • Reform and regime changes in many developing markets
  • Internet and mobile banking technology for banking solutions.

The main purpose of a financial system around the world is to facilitate the flow of funds from savings- surplus units (SSUs) to savings-deficit-units (SDUs) in the best way possible. Commercial banks play the role of an intermediary in the process. If there are no intermediaries like commercial banks, the flow of funds would have to be directly from the lenders to the obtainers. This direct financing has a few major problems. One is the absence of double coincidence of demands in terms of the characteristics of the financial product. E.g., the lender may prefer a longer span, and more denomination for the financing as compared to the obtainer. Financial intermediaries like commercial bank seek to resolve such problems.

Today modern banking and Islamic banking operations involve “debt-related Riba” by the Holy Quran, in that they obtain and lend against a certain specific- paid or received- revenue. These operations also involve “sales-related Riba” prohibited by well-known hadith, in that they deal in money.

Islamic financial institutions are differentiated by keeping away from granting or obtaining on interest. An Islamic banking system accepts investment deposits on a profit sharing basis. It gives some of these funds to partner on a profit sharing basis. But now a day other medium of finance allowed by Sharia are in more use so that these Islamic banks can earn more profits for their shareholders and customers. Islamic investment association or group operate like mutual funds. They invest clients' investment in common stock and utilize them to earn profits through Islamic modes of finance as Islamic banks are doing.

In a more broad way to understand, there are two main ways in which Islamic banks and other Islamic financial institutions can mobilize private savings for public sector projects related to infrastructure. The first way depends on profit sharing and can be used to projects capable of yielding measurable profits e.g. in the form of a tax at the toll which is charged for using a highway or motor car licensing fees for using roads, etc. Funds prepared in this framework can be divided by a percentage share of the actual profits.

Secondly, funds can be prepared by selling at a higher than cost price, benefits of certain infrastructures which are 'purchased' on low payment from the private sector which builds them for the government in hope of good profit returns on their investments. Hence, an airport can be built by a private association or group, local or foreign, and sold or rented to the government which pays the installments due out of money collected as airport tax and landing fees etc.

Islamic economists have devised certain financial instruments under both frameworks reported above.

Over the last 20 years, IDB (Islamic development bank) has played a vital role in the making and strengthening of specialized activities performed by various financial infrastructure institutions for the Islamic financial infrastructure these include:

  1. International Islamic Centre for Reconciliation and Commercial Arbitration (IICRCA)- Dubai, U.A.E. IICRCA conduct mediation of disputes and to adjudicate on financial and commercial disputes which can arise between Islamic financial institutions, and between these institutions and/or third parties.
  2. TheIslamic Financial Services Board (IFSB)- Malaysia. It promotes development of standards and effective supervision guidelines for the Islamic financial services industry and also recommends their adoption by relevant regulatory authorities.
  3. TheInternational Islamic Rating Agency (IIRA)- Bahrain. Conduct rating of entities, determine financial strength, fiduciary risk and credit worthiness of the issuer along with assessment of Sharia(The Islamic Law) compliance.
  4. Liquidity Management Centre (LMC)- Bahrain. Facilitate development of inter-bank money market and to provide short-term investment opportunities with greater Sharia credibility.
  5. TheGeneral Council of Islamic Banks and Financial Institutions- Bahrain. Promote cooperation amongst Islamic financial institutions, develop images, rules, provisions, share related information, and develop better understanding with regulatory bodies.
  6. International Islamic Financial Market (IIFM)- Bahrain. Develop Sharia enhancement and guidelines for issuance of Islamic financial instruments, and to encourage active secondary market trading.
  7. TheAccounting and Audit Organization for Islamic Financial Institutions (AAOIFI)- Bahrain. Develop accounting, auditing and Sharia standards for adoption in the financial reporting of Islamic financial institutions.
  8. TheIslamic Research and Training Institute, (IRTI)IDB - Jeddah, Saudi Arabia. To undertake research and impart training in Islamic economics and assist in the development of Sharia-compliant financial sector.

for the development of Islamic finance, at domestic level, national level and also at international levels. The Islamic standard and framework plan proposes a vision for the industry of Islamic finance and sets a strategy to develop Islamic financial practicing principle at national levels and targeting industry on building institutional capacity in different functions of the financial sector ,these are 3 phases for the development and implementation of Islamic financial framework :development of links in between all financial and non-financial institutions ; creates environments for competition in between institutions ; and increase performance of domestic ,national and international institutions through integration of all the Islamic financial institutions . to increase the efficiency of all the Islamic financial institutions and industry , a key issue is to develop a Sharia-compliant and creditor and borrowers rights system'. The financing in Islamic banking system is asset-based and share the risk based on risk-sharing principles, to prosecute in the event of bankruptcy a legal system develop in all member of Islamic financial institutions countries which adopted Islamic banking system

, which in the event of bankruptcy of any financial institutions or creditors provides rapid Sharia, will increase the reliability of Islamic institutions .The on ground steps which needed to realize the potential of Islamic financial institutions for building infrastructure are, firstly, to identify the demand of consumer in details and offer all the available Islamic financial institutions to prepare the required funds. The next job is to identify the necessary equipment or instruments suitable for such task, which can include a particular kind of operations or group of operations . All the domestic national and international Islamic institutions and government needed to work together in this crucial task. Thirdly the issues should be launched with the assistance of these institutions and in general public attract them to buy them through these institutions. Lastly, development of a primary market in these institutions will be needed something doing, especially in the early stages. A market former is required. This task can be played by an organization (a partnership, a joint stock association or group) or even by a bank owned by the state, as the situation may demand. In the Islamic banking experience the context of the first step, the concept of a large pool of investable funds which can deal with many projects had gained favor over project-wise fund mobilization. This may be more suitable for a country having the task of building several kinds of infrastructure simultaneously such as telecommunication, highways and canals.

The four steps: project, instrument designing, issue and help developing an efficient primary market, are, each in its own turn, vital for the preparation of private savings for infrastructure building through Islamic financial institutions. They are same work doing them in Islamic framework has already started.


The Economist, Article, Islamic Banking, Journal, 2005

ACCA, Study Text. United Kingdom, BBP School Of finance, BBP Publishing, 2012.