3.1 The Financial System
The possibility of a financial system that would conform with the laws of Sharia was
discussed as early as in the 1940s (Warde 2000), but the idea was not put in practice until the
establishment of a rural bank in Egypt in 1963, followed by a cooperative bank in Pakistan in
1965. Since the creation of the Islamic Development Bank (IDB) in 1975 (Elgar 2003), the
Islamic banking system has developed into a rapidly growing segment of the international
banking and capital markets. Today there are more than 200 Islamic banks operating in over
70 countries, including most of the Muslim world and several Western countries. In addition,
there are 50 Islamic insurance (takaful) companies which are operating in 22 countries as well
as Islamic investment houses, mutual funds, leasing companies and commodity trading
companies. There are also hundreds of small Islamic financial institutions such as urban
cooperative credit societies and financial associations that are operating at a local level and
dealing with urban units, small business firms and individual households (Elgar 2007).
So what is Islamic banking? It is defined as those financial institutions that are based in their
objectives and operations, on the Islamic law, the shari‟a. Shari‟a as a legal system is based
on the code of behavior derived from the Qur‟an, the Holy Book of Islam, and the Tradition
of the Holy Prophet, the Hadith. For banks to be able to conform to Islamic rules and norms,
five religious features must be followed in terms of investment behavior (Elgar 2007):
Riba is prohibited in all transactions.
Business and investment are based on halal activities.
Maysir (gambling) is forbidden and transactions should be free from gharar
(speculation or uncertainty).
Zakat (almsgiving) must be paid by the bank to benefit society.
All activities should be in line with Islamic principles, and there should be a special
shari‟a board that...