Understanding the History of Islamic Banking and Finance:

A large number of the teachings of Islam deal with economic affairs. One of the five questions Muslims will face on Judgement Day will be: “How did you earn your wealth and how did you spend it?” Our earnings must come from halal means (permissible according to Islamic Law), and must be spent on halal categories of expenditure. The necessities of governing an expanding empire led early Muslim writers to discuss halal methods for raising revenues for the state, as well as the obligations of the state (according to Islamic law) to spend on the public. Thus, public finance is a sophisticated and well developed field within Islamic scholarship. Modern Islamic economics is based on this history of Islamic banking and on these early Islamic teachings. Islamic banking history has also been strongly shaped by the colonization of Islamic lands, struggles for independence, and the need to respond to assertions of the superiority of Western knowledge.

Fundamental Elements Describing the History of Islamic Banking:

Knowledge of permanent and enduring value is that which permits us to realize our potential as human beings. This is recorded in the Quran and translated into human experience by the Prophet Muhammad (s.a.w.) as captured in the Hadeeth (records of the sayings and actions of the Prophet or his companions). Other knowledge can be relevant and important in particular historical circumstances. For example, knowledge of castle building, trolabes and sailing ships was important in an earlier era. In contemporary times, the development of Islamic economics represents a Muslim response to the challenge created by the ascendance of the West. Increasing materialism, changing attitudes towards poverty, and other effects of the development of capitalism are aptly summarized in the transition from the Biblical “love of money is the root of all evil” to Shaw’s “lack of money is the root of all evil”. Since the economic system (capitalism, communism, socialism) is a major feature of Western identity, engagement requires a Muslim response in these terms. This is complicated by the fact that economics is not a high priority in Islam. As put by Mufti Shafi (1978):

There is no doubt that Islam is opposed to monasticism and considers economic activities to be permissible, desirable, and even necessary and required at times in the history of Islamic banking. Economic progress is desirable for men, and the earning of a Halal livelihood is required after the religious requirements. At the same time, it is equally self evident that in Islam the fundamental problem of man is not economic and economic progress is not a goal or objective of life for humans. Mufti Shafi goes on to explain that in Islam, economic activity is a means to an end, and not an end in itself. This difference in purpose is fundamental, and is the basis for all other differences between Islamic and Western views on economic affairs. There is no doubt that many Islamic teachings relate to economic affairs, and there exists a vast literature on many aspects of economic affairs, starting from the earliest periods of Islamic history. A survey and summary of the economic thought of early Muslims is given. In Sadeq and Ghazali (1992) and Islahi (2008) provides an excellent literature survey of Muslim economic thought in general. Nonetheless, economics was never considered in isolation, as a separate subject, since it is always a means to an end, and never an end in itself. Numerous specific goals or ends for economic activity will be discussed in what follows. As a broad general principle, Islamic systems in all spheres are built with the goal of promoting community feeling and cooperation among all members of society:

And hold fast, all together, by the rope which Allah (stretches out for you), and be not divided among yourselves; and remember with gratitude Allah’s favour on you; for ye were enemies and He joined your hearts in love, so that by His Grace, ye became brethren; (Q3:103)
Other verses (Q8:62, 63) state that all the treasure in the world cannot purchase love between hearts. This prioritization of community feeling over material wealth differentiates Islamic systems from the competitive self-interest based individualistic systems at the heart of modern economic theory.
history of Islamic banking

Birth History of Islamic Banking is Islamic Economics:

The birth history of Islamic finance, which is primarily based on the prohibition of riba, can be dated to the early twentieth century. The needs of liberation movements gave a distinct shape to Islamic thought all over the Islamic world. It was necessary to argue that Islam required Muslims to struggle for freedom, and that it offered a better way of life than the dominant Western systems of capitalism and communism. This forced Muslim thinkers to delineate and distinguish Islamic socio-political and economic systems. Although these issues have been discussed by many Muslim thinkers, two major figures devoted substantial energy and time to developing the basis and defending the need for a distinct Islamic economic system: Mohammad Baqir Al-Sadr (1961) in his book Our Economy, and Sayyid Abul A’la Maududi in numerous books and articles (e.g. Economic System of Islam, 1970). Chapra (2004) summarises this historical background and the views of Maududi, and gives citations to the latter’s numerous works. Chapra also remarks on the courage it took to formulate an Islamic system and defend it against the dominant and apparently tremendously successful Western systems in the early twentieth century. Mirakhor (2005) presents a survey of trends in Islamic economics, which includes some discussion of the contributions of Baqir Al-Sadr. T. M. Aziz (1993) and Wilson (1998) have discussed at much greater length the contribution and legacy of Baqir Al-Sadr. If we look at the history of Islamic banking, the founders of Islamic economics (Al-Sadr, 1961; Maududi,1947, 1970) agree that the focus of Islam is on human and spiritual development, and the purpose of an economic system is to promote justice and equity. Both believed that applications of Islamic laws and guiding principles in the economic sphere would bring advances in human welfare and be superior to Western systems for handling economic affairs, which promote only material welfare. To summarise, it is worth putting the development of Islamic economics into a broader perspective. During the eighteenth and nineteenth centuries, European colonization of Muslim lands had destroyed functioning political, social, health and educational structures11. This was considered necessary for progress since, as Lord Cromer, the British counsel in Cairo from 1883-1907, said “…as a social system, Islam has been a complete failure. Islam keeps women in a position of inferiority…it permits slavery…its general tendency is intolerance towards other faiths…” Said (1978, Introduction, part III) provides a penetrating analysis of the effects of European colonisation on the production of Western knowledge about the Orient; he writes that “All academic knowledge about India and Egypt is somehow tinged and impressed with, violated by, the gross political fact (of imperialism).” It is now widely agreed that good institutions and public participation in and ownership of socio-political processes are crucial to progress and development (broadly defined). Indigenous institutions, created and adapted to perceived public needs, had been replaced during the colonial era by alien and exploitative governance structures signed solely for the efficient extraction of revenues. Replacing these relics of the colonial era and adapting them for use in states based on Islamic principles, as well as creating new institutions in line with Islamic ideals, is a huge task, requiring both vision and the political power and energy to implement the vision. The task is further complicated by powerful vested interests, as well as European interests and fears of Islam. The failure of alien, authoritarian, and exploitative Western institutions to take root in Muslim societies has been attributed to Islam and characterised by some as backwardness (e.g. Lewis, 2003a, 2003b, but see also rebuttals by Alam (2002), Dalrymple (2004) and Hirsh (2004)). Concerted efforts are being made to co-opt and coerce Muslims into following Western agendas, with explicit encouragement to creating versions of Islam amenable to Western interests and fomenting divisions among Muslims – see, for example, Benard (2004).The struggle to find a suitable compromise between the demands of modernity and the demands of Islam is under way throughout the Islamic world, with a wide spectrum of positions being adopted by different groups. Maulana Syed Abul Hasan Ali Nadvi (1980) gives a Muslim point of view regarding this struggle, which will shape the future of the Muslim world and of which the development of Islamic economics is part. The study contents on the “history of Islamic banking” is taken from the Islamic banking training and CIFE – the best Islamic finance certification.

Concept of Halal and Haram:

Islam has introduced concept of Halal (lawful) and Haram (unlawful) in its economic system. In fact the foundations of the Islamic economy have been laid on this concept. This concept reigns supreme in the realm of production as well as consumption. Certain means of earning livelihood and wealth have been declared unlawful such as interest, bribery, gambling and games of chance, speculation, short weighing and short measuring, business malpractices, etc. Unlawful means of earning are strictly forbidden and a follower of Islam is permitted to earn through lawful and fair means. Similarly in the field of consumption certain items of food are unlawful such as dead animals, blood, swine flesh and animals slaughtered in the name other than that of Allah. Even expenses on certain items such as drinks, narcotics, debauchery, prostitution, pornography, things that promote obscenity and vulgarity, lotteries and gambling are strictly inadmissible.

Now let us glance through relevant verses of the Quran and Ahadith of Muhammad (PBUH), the Prophet of Islam, to highlight in brief the concept of halal and haram.


O mankind! Eat of that which is lawful and wholesome in the earth, and follow not the footsteps of the devil. Lo! he is an open enemy for you (2:168)
And eat not up your property among yourselves in vanity, nor seek by it to gain the hearing of the judges that ye may knowingly devour a portion of the property of others wrongfully. (2:188)
O ye who believe! Eat of the good things wherewith We have provided you, and render thanks to Allah if it is (indeed) He Whom ye worship. He hath forbidden you only carrion, and blood, and swine flesh, and that which hath been immolated to (the name of) any other than Allah. But he who is driven by necessity, neither craving nor transgressing, it is no sin for him. Lo! Allah is Forgiving, Merciful. (2:172-173)


Abu Hurairah reported that the messenger of Allah said: Verily Allah is pure. He does not accept but what is pure …..Then he mentioned about a man disheveled in hair and laden with dust, making his journey long and extending his hands towards heaven: O Lord! O Lord! while his food was unlawful, his drink unlawful, his dress unlawful and he was nourished with unlawful things. How he can be responded for that? (Muslim)
Abdullah-bin-Amr reported that the messenger of Allah cursed the bribe taker and the bribe giver. (Abu Daud)
Abu Masud Al Ansari reported that the messenger of Allah forbade the price of dogs, earnings of prostitute and foretelling of a soothsayer. (Bukhari,Muslim)
Jabir reported that the messenger of Allah…..forbade the sale of wine, dead animals, pigs and idols……. (Bukhari and Muslim)
Jabir reported that the messenger of Allah cursed the devourer of usury, its payer, its scribe, and its two witnesses. And he said that they are equal (in sins). (Muslim)
Abdullah-bin-Amr reported that the messenger of Allah prohibited intoxicants, games of chance, card-playing and Gobairah and he said: Every intoxicant is unlawful. (Abu Daud)