Dealing in interest may be prohibited by religion but, contrary to what many many suppose, Islamic Banking is a relatively recent phenomenon having developed over the past 50 years. Modern banking reached Muslim countries at the end of 19th century and early 20th century, primarily through European trading companies which engaged in trade with Muslim merchants and their enterprises. They required banking facilities in Muslim countries to provide the medium for exchange (money!) for trading transactions. Although Muslim traders avoided the use of “foreign banks” for religious and sometime nationalistic reasons, growth of trade did, in time, require them to maintain current accounts and use bank transfers systems. Borrowing and saving with a bank continued to be avoided in order that there was no dealing in interest.
The issue of interest free banking came to the attention of Muslim Intellectuals in the 1940’s and 1950’s. By this time economic and financial influences had produced a number of local and national banks established along the lines of interest based foreign banks. They had started to bring the banking system and its services to the local population. By this time Governments of Muslim countries, particularly those, which gained political independence, had of necessity to engage in international financial transactions using banking systems. The requirement for commercial banking was recognised. The challenge was to avoid the concept of interest within commercial banking. The route to this was the development of the concept of profit and loss sharing (Mudarabha), the key concept from which the structure of most Islamic Banking products and services are derived.
The 1960’s and 1970’s provided the political background and platform by which to attract the attention of Muslim Governmental and National Financial Institutions. Through a number of high profile conferences, where the theory of Islamic Banking was brought to practical application the Islamic Development Bank, an inter-governmental bank was established on strictly interest free banking principles was established, applying the concept of profit and loss sharing to its transactions and activities.
The first interest-free bank, the Dubai Islamic Bank was established in 1975. .A few others followed in Sudan, Egypt and Kuwait in the late 1970’s.Apparently a number of earlier interest free banking ventures were initiated in the 1940’s/50’s and 60’s in a number of Muslim countries but they did not survive or did not survive in strictly Islamic Banking form. Most private Islamic Banking have been established in Muslim countries. However, a number have been established in western Europe and, indeed, a number of well know international banks, such as Citicorp and HSBC have seen the opportunities for the development and provision of Islamic Banking products through selected subsidiaries and branches.
In most countries the establishment of “interest free” banking has been through private initiatives and were confined to that bank. However, in Iran and Pakistan it was lead by government initiative. Outside Pakistan and Iran there are in excess of 50 interest free banks including a number in Western Europe
In Pakistan since 1981 all domestic commercial banks have been permitted to accept deposits on the basis of Profit and Loss Share (PLS). In 1985 the banking system was transformed to between January and July of that year. From July 1985 no banks were able to accept any interest bearing deposits and all existing deposits became subject to PLS rules, though some (few) operations were allowed to continue on the old basis.