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1 Islamic Banking –Growth and Challenges on 15th May 2011, 2:28 pm

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Islamic Banking –Growth and Challenges

Introduction:
This study on Islamic banking focuses on growth and challenges of Islamic banking system. The 2008-2009 global financial crises have brought to the forefront the issue of break-down of trust and confidence in the financial system. This crisis resulted due to inadequacy of regulations in conventional banking, loopholes in capital adequacy norms and credit crunch. This crisis was least affected by Islamic banks mainly due to their nature of operations. Islam has a very specific approach to commercial transactions, on the law of contract, interest charges, indeed to the very nature of property.
Islamic banking is a financial system that adopts principles of Sharia, the sacred law of Islam. The basic foundation of Islamic banking lies on promotion of fairness in transactions, prevention of an exploitative relationship, sharing of risks and rewards between principals in all financial or commercial transactions and prohibition of interest.
Today Islamic finance and insurance industry is worth $1trillion. Over the last decade the growth in Islamic banking has been between 10 and 15 percent. The Banker’s third annual survey in 2009 states that top 500 Islamic financial institutions worldwide grew from $639 in 2008 to $822 indicating a growth rate of 38.6 percent while top 1000 conventional bank’s assets declined from 21.6 percent to 6.8 percent in 2009.

Mit Ghamr Project
In 1960s, Muslim thinkers desired and explored ways and means of operating commercial banks in an interest free environment but were not successful. Later in 1963 the first Islamic interest-free bank started in a rural area named Mit Gharmr, Egypt. People were religious and they did not place their savings in any bank knowing that, interest was forbidden in Islam. Under such circumstances, the task was not only to respect Islamic values concerning interest, but also to educate the people about the use of banking.
In this system no interest was paid on savings accounts, but withdrawals could be made on demand. Small, short-term, interest-free loans for productive purposes were made. Funds in investment accounts were subject to restricted withdrawals and invested on the basis of profit- sharing.
The Mit Ghamr project was successful, as deposits increased between 1963 and 1966. The bank was cautious, rejecting about 60 percent of loan applications and the default ratio was zero in economically good times. Later the project was eventually abandoned for political reasons. Nevertheless, it had shown that commercial banking could be organised on a non- interest basis.

Islamic financial services
Commercial banking risk falls into four categories- financial, operational, business and event risk but Islamic financial institutions face a unique mix of risks. Risk sharing arrangement results from contractual design of financial instruments based on principles of shariah. It shares a unique relationship between the bank and the Investment accounts holder (IAH).


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