Islamic Banks and Its Role in Development
By admin February 13, 2018

Islamic Banks appeared in the late 1950s and the earliest ones were established in Pakistan and northern India. Islamic banking is banking or banking activity that is consistent with the principles of Sharia (Islamic law) and its practical application through the development of Islamic economics. As such, a more correct term for Islamic banking is sharia-compliant finance. Sharia prohibits acceptance of specific interest or fees for loans of money, whether the payment is fixed or floating. Investment in businesses that provide goods or services considered contrary to Islamic principles (e.g. pork or alcohol) is also prohibited. After 1975, Islamic Banks rose on a large scale all over the Middle East. Some of Islamic Banking institutions in the Middle East include, the famous Islamic Bank of Dubai, the Islamic Development Bank of Saudi Arabia, Egypt and the Sudanese Faisal Islamic Bank, Kuwait financial institutions and a number of other Islamic Banks have been established. Almost all of the Islamic countries have some form of Islamic banking institution.

As of 2014, Islamic Banks and sharia-compliant financial institutions contributed approximately 1 percent of total world assets. Even though Islamic Banks still make up only a fraction of all the banks in the Middle East, they are growing faster than the whole, at an annual rate of 17.6 percent between 2009 and 2013 and is projected to grow by 19.7 percent a year to 2018.

Islamic Banks have similar functions to conventional banks such as mobilizing funds from savers, lending money to lenders and create credit, facilitate transactions among others. The functions of Islamic Banks are extremely useful and socially desirable. The functions of conventional banks are tarnished by the interest that limits their activities of money trade and they finance more in the view of short-term and personal loans. These focus areas mean conventional banks do not solve the problem for venture capital needs and their contribution to the economic growth will have less real potential.

Although Islamic banking is still a small part of the economy and financial sector even in MENA countries, many studies have shown that Islamic banking is positively associated with economic growth. Islamic banking poses two improvements on the conventional banking system. First, Islamic Banks offer more lending to the production process, aiming to contribute in companies’ capital. The financial resources allocation is more efficient than the pure lending activities. The waited impact to the economy will be more important. Secondly, The Islamic Banks will guarantee people that interest rates will not be included in their contract.
Both IMF and World Bank consider the Islamic financial system as steadier and less inflationary than the conventional banking system. Based on the “z-score” analysis, Cihák and Hesse (2008) showed that Islamic Banks are less risky and financially stronger than conventional banks. I Conventional bank deposits are susceptible to economic shocks and can lead to bankruptcy, while Islamic depositors share the risks for economic shocks and allow for adjustments.

In conventional banking, if borrowers face financial difficulties and cannot pay back in time, they will be punished by the higher interest rate, however, in Islamic Banks, the debt value and profit are fixed. This means the value of debt can be repaid in installments without a penalty fee and only financial cost will be paid. So in many ways, Islamic banking is more reliable than the conventional banking system and therefore the Islamic banking could bare more social responsibilities to help financing for lower-income From the microeconomic perspective, Islamic Banks issue microloans to impoverished families and small business in developing countries and therefore addresses the economic growth and equity problems at the same time. Islamic banking could also help to achieve the Sustainable Development Goals by financing environmental and social financial efforts and activities.


For More Information:
Institute of Islamic Banking and Insurance

Islamic Finance and the Role of IMF

Islamic Finance by the World Bank

Islamic Research and Training Institute: Global Report on Islamic Finance 2016


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