Chapter 1

History and development of

the Islamic banking system.
Nor Izzuddin Bin Norrahman
BBA. (Hons) Islamic Finance
 Contents
History of Islamic Banking
Early era
Middle era
Modern era
Development of Islamic banking system in
selected countries.
Malaysia
Egypt
Sudan
Iran
 Introduction
Islamic banking system (IBS) is defined as
a banking system whose principles of its
operations and activities are founded on
Shariah rules.

Islam forbids Riba which is includes in the

transaction of conventional banking. So,
Islamic banking system which is free from
Riba has to be establish for the sake of the
ummah.
 History of Islamic Banking
The establishment of Islamic bank is
in 1960s.
However, banking activities exist
long before the 1960s in the Islamic
history.
Before the era of Prophet Muhammad
p.b.u.h, there were trade activities
conducted in Mecca.
These activities continued even after
Islam became rooted in Mecca and
 Continue
From the historical point of view,
Islamic banking can be divided into
three eras:
First era (Early era)
The early year of Islam until the period of
Caliph ar-Rashidin
Second era (Middle era)
Streches from the era of the caliphates until the
fall of the Uthmaniyah Empire.
Third era (Modern era)
The era of modern Islamic banking.
 Early Era
Before Prophet Muhammad p.b.u.h
received the divine revelations, Mecca
was a city of trade.
Its business activities continued even
after Islam became rooted there.
Example of the activities: Safe-keeping
There were activities that not against
the Shariah rules and there were also
activities that against it.
 Continue
With the arrival of Islam, the practice
of Riba was no longer permitted.
Nevertheless, activities which is not
against the Shariah rules were
allowed.
 Middle era
Began with the end of the reign of Caliph
Uthman in the year 661 A.C.
It witnessed the continuation of banking
activities which were practiced in the early
era of Islam.
With the fall of Islamic empire and followed
by the fall of the roman empire, there were
significant adverse impact on the
economic activities of Muslim countries.
 Continue
European countries in the 12th century
revived the economic and expand it to the
Muslim countries.
Islamic banking system was failed to
expand on that era.
However, the development of Islamic
banking system took place in terms of
fatwa by Muslim jurists pertaining to issues
of muammalat, particularly those involving
Riba.
 Modern Era
Started with the establishment of Mit Ghamr
Savings Bank in 1963
This is however does not mean that no earlier
attempts were made.
Mit Ghamr Savings Bank
From Egypt
Provided basic banking services.
Deposits
Loans
Equity Participation
Direct Investment
Social Service

Used the Shariah principles which well received by the

local community and the farmers.
 Continue
Set back for Mit Ghamr Savings Bank
Mid-1967
Political unrest in Egypt, the operations
were taken over by the National Bank of
Egypt.
Interest-free operations were reverted to
interest-based system
However, the operations of interest-free
banking were studied by Muslim scholars
all over the world.
 Continue
The problems are the scarcity and unavailability
of proper guidelines concerning principles and
practices of the interest-free banking.
So, the first task is to formulate the guidelines
and the frameworks on the practical aspects of
Islamic Banking System.
Another problem arose where it was a daunting
task finding Muslim Economists who were also
well versed in the knowledge of Shariah laws.
 Continue
The need to establish an Islamic Banking
System reach its peak around 1970s.
The action were taken by private
initiatives rather than the government.
King Faisal bin Abdul Aziz al-saud (The
late Saudi Arabian King)establish the
Organization of Islamic Countries (OIC)
and urged Muslim countries to set up
their own Islamic Banking System.
 Continue
The result:
The establishment of Islamic
Development Bank (IDB) in 1975.
Dubai Islamic Bank (1975)
Faisal Islamic Bank of Egypt (1977)
Bank Islam Malaysia Berhad (1983)
 Continue
With the establishment of the Islamic
bank, it continues with:
Islamic inter-bank Money Market (1994).
Establishment of Accounting and
Auditing Organization For Islamic
Financial Institution (AAOIFI) in 1990.
Other establishment.
 Modern
Middle Era
Era
Early Era
Developments of Islamic Financial and
Banking Institutes According to
Specific Periods
1950s
Models of Islamic Banking and financial system was presented.
Twin mudharabah concept were suggested.
1960s
The practice began.
The recommendation of Operation mechanisms for IFI.
Rise and fall of Mit Ghamr Savings Bank.
Establishment of Tabung Haji in Malaysia, 1966.
1970s
Islamic Financial Institutions were established. (Banks / non-banks)
Academic institutions were set up.
The establishment of Mudharabah financial mechanism.
Research center, publications of books and the held of International
Islamic Economics Conference were done.
Developments of Islamic Financial and
Banking Institutes According to
Specific Periods
1980s
Government intervention.
More private sector banks.
Variety of Islamic Banking products.
More scholars and economist in the west who interested in Islamic Banking.
Conventional Banks offer Islamic Banking Window.
Growth of Islamic Index and trust funds.
Pakistan, Sudan, Iran and Malaysia attemped to use the Islamic system.
Establishment of Fiqh Academy of OIC and other Fiqh Boards.
Establishment of Islamic trust funds.

1990s
Growth in the Islamic window concept.
Enhancement in asset-based financial instrument.
Establishment of Islamic Index.
Regulations and supervision given attention.
Standards of AAOIFI issued.
Developments of Islamic Financial and
Banking Institutes According to
Specific Periods
Early 2000s
Continuous growth
Completion of the architecture of Islamic
Finance.
Attention on Risk management and corporate
control.
Capitalization of Islamic banks trough mergers.
Creation of asset-backed securities market.
The formation of IFSB in 2002.
Establishment of the International Islamic Rating
Body, Bahrain.
History of Islamic Banking System in
Egypt
Started with the establishment of Mit Ghamr
Savings Bank in 1963
Followed by:
Nasser Social Bank in 1972
Faisal Islamic Bank in 1977, and
International Bank for Investment and Development
in 1980.
Offers 2 types of deposit accounts:
Savings Account
Interest-free
Investments Account
Profit and loss sharing
 Continue
Due to the political changes in Egypt, its
operation suffer a setback.
Taken over by the National Bank of Egypt
in mid-1967.
Thus, riba based financing were
introduced.
In 1971, the Islamic Banking system was
revived by Anwar al-Sadat when the
government established the Naseer
Social Bank in 1972.
History of Islamic Banking System in
Sudan
Underwent two distinct periods:
Period of full government support
Enjoyed encouragement and full support
from the government.
Rapid development of Islamic banking in
Sudan.
Period of distress in the banking sector
When the support was withdrawn, banks in
Sudan faced with obstacles.
 Continue
The concept of Islamic banking was
first introduced in Sudan with the
establishment of Faisal Islamic Bank
of Sudan (FIBS) in 1977.
Under a special law known as the
FIBS Act of the national peoples
council.
In 1984, the government Islamized
the entire banking system.
History of Islamic Banking System in
Iran
As with Pakistan, Iran has also converted
its entire financial system to Islamic
Banking System.
Began with Islamic revolution in 1979.
Implemented in a gradual basis.
Took 6 years for the system to fully
implemented.
First step: introduction of a service charge
to replace the riba system in 1981.
 Continue
A committee comprising bankers,
academicians, businessman and
ulama proposed a legislation called
Law for Usury-Free Banking in August
1983.
The law required banks in Iran to
fully convert their operations in
accordance with Syariah principles.
History of Islamic Banking System in
Malaysia
Started with Islamic resurgence movement in
1970s.
In 1980, Bumiputra Economic Congress made a
resolution required the government to allow
the pilgrimage board (Known as Lembaga
Tabung Haji) to establish an Islamic Banking.
1981 The government appointed National
Steering Committee on Islamic Banking to
studied the operations of FIBE and FIBS.
A report was made by the committee and
submitted to the government on 1982.
 Continue
1983 Islamic Banking Act was gazetted and
came to effect on 7 April 1983.
The first Islamic bank Bank Islam Malaysia
Berhad (BIMB) was establish under Companies
act 1965 on 1 March 1983 and commenced
operations on 1 July of the same year.
1994 The government launched the
Interest-free Banking Scheme.
The scheme allow financial institutions to offer
Islamic Banking products and services.
 Continue
1994 Islamic inter-bank market was
introduced.
1997 BNM established the National Shariah
Advisory Council on Islamic Banking and
Takaful (NSAC).
1999 Second full-fledged Islamic Banking was
established, the Bank Muammalat Malaysia
Berhad (BMMB).
2004 BNM allow foreign Islamic Bank to
operate in Malaysia.
2006 The launching of the Malaysia
International Islamic Finance Center (MIFC).
 Summary
The system can be traced back to the
early days of Islam.
The banking activities were done in the
time of Prophet Muhammad p.b.u.h.
but were not developed.
With the rise of Europe in 12 th century,
the conventional banking system was
introduced to the Islamic countries and
Islamic banking were ceased to exist.
 Continue
The establishment of Mit Ghamr Savings
Bank in 1963 sparked the Islamic
countries to set up their own Islamic Bank.
However, the development of the Islamic
Banking differed one from the another
Islamic countries.
Until then, Islamic continues to grow and
in 2008, there were more 300 Islamic
Banks in the world.
The end of Chapter 1
 Tutorials
Please find out the current amount of
Islamic Bank in Malaysia (categorized
it with local or foreign bank) and the
world.

The different between Early era of

Islamic Banking with the Modern era
of Islamic Banking.
 Refference
Sudin Haron, W. Nursofiza, (2009).
Islamic Finance and Banking
System : Philosophies, Principles &
Practices. Selangor, Malaysia.
McGraw-Hill (Malaysia) Sdn. Bhd.