Principles of Islamic banking and finance/PIBF201/Introduction/Overview

This section provides necessary background for studying Islamic banking and finance. As the name suggests, Islamic banking and finance was introduced in Muslim countries to meet the aspirations of their masses to do their commercial dealings in accordance with Islamic business ethics. During the colonial period many economic and financial institutions were established in Muslim countries moat importantly commercial banks and insurance companies. The most serious issue with these institutions (among other things) was their dependence on interest which was seen as the prohibited riba under Islamic law (shari'ah). When Muslim countries became independent after the second world war, there was a widespread desire to reorganize these institutions on the basis of alternative modes of financing.

Dubai Islamic Bank was the first Islamic bank which was established in 1975. It was made possible through joint efforts of professional bankers, economists and Islamic religious scholars. The role of religious scholar was to validate the Islammicity of all products and services introduced by the bank. This role has been institutionalized as Shari'ah Boards that each and every Islamic financial institution must constitute before it can start its operations.

In order to study Islamic banking and finance, it is, therefore, important to have a reasonable understanding of the nature of Islamic law (Shari'ah) and Islamic jurisprudence; the philosophy of deriving Islamic laws from primary sources.

A financial system is a compatible sub-system of a broader economic system. It facilitates in achieving the goals and objectives of the economic system. Conventional banks and financial institutions are part of capitalist systems which champions free markets, efficiency, creation of wealth through private initiatives and minimal government interventions. Islamic banking and finance, likewise, must be studied with a knowledge of the contours of Islamic economic system. Second section of this unit deals with this topic.

Section 3 discusses the rationale for Islamic banking and finance which is to avoid riba (interest), gharar (unnecessary ambiguity in financial contracts), and mysir (gambling like financial transactions).

The last two sections of this unit explain alternative modes of finance that were evolved in attempts avoid the three prohibited elements mentioned above.