History of Islamic banking - Term Paper Example

One of the major functions of commercial banks is to mobilize savings and offer loans to the potential investors in the economy (Saeed, 1996). The system of regular banking asks for a certain price known as interest on the loans being given to the investors (USAID, 2005). The rate of interest charged on loans becomes directly proportional to the time period for which the loan is offered. The system is not the same for all the banks following Islamic banking system. This process of banking donnot involve in offering loans that are interest free.

It is believed that ‘riba’ or ‘usury’ which is known as interest is firmly forbidden under the regulations of Muslim law. Islamic banks are rapidly growing all over the world both in Muslim as well as non Muslim nations. So apart from Islamic nations like Egypt, Sudan etc; Philippines, U.K., Denmark are also widely establishing Islamic banks in their economies although they comprise Muslim population as minorities. Islamic banking theory thinks that it is incorrect to take benefits from borrowers.

Unlike the commercial theories of regular banking, Islamic banking follows ‘riba’ which is actually based on concepts like ‘mudaraba’ and ‘musharake’ (Hamza, 2013). Thus by this process the creditors cannot raise the nominal value of loans offered. The board of Islamic banks are formed with Shariah scholars who would see that the interest of the laws is duly considered by almost all the banks following Islamic laws. The principles of Islamic banking explains paying as later after buying is ‘halal’ but if someone charges on the credited money even that is also punishable (Hosein, 2011).

The regular banks deny loans without collaterals or interests. Flexible verses Fixed Return on Deposits The commercial regular banking system offers fixed rates of return on the deposits made by the depositors. The rate of fixed return varies according to the time period for which the deposits are made. In general there are three types of deposits or accounts that can be opened in regular banks which are savings, current and fixed deposits. As estimated the highest return is received from the fixed deposits, then savings and finally current account deposits.

The system is not the same with Islamic banks, the depositors depositing money in such banks get variable returns. This is because the returns are given from the profits made by the Islamic banks. So the depositors may land up with either profit or loss. These banks follow a strict rule of investing in the poverty alleviation and rural development programs. Often due to the greater importance given in the welfare aspects potential deposits face losses kept in these banks. It is found that the lack of interests in depositors is becoming problematic in the expansions of such banks.

It is stated despite of all the problems faced by the depositors no one has actually faced problems of making a loss in an Islamic Bank. The command deposits kept in the Islamic banks are under the contract of ‘Wadiah’. The fund deposited in the Islamic banks is not used for investments in the market. The fund can only be invested if it is authorised by the depositors. The different current, savings, or other deposit plans offered by an Islamic bank are always made very attractive to the depositors.

The contract of ‘Mudharaba’ often set the demand deposits in the Islamic banks. Sometimes the rate of interests that the depositors receive is directly proportional to