Historical and religious context

Historical and religious context:

The development process of Islamic finance commenced at the beginning of the 7th Century when Prophet Muhammad (S.A.W) is professed to have received revelations directly from Allah. In Muhammad (S.A.W)’s lifetime, Islamic methods of finance often drew upon examples from the Prophet’s experiences. For example, Muhammad (S.A.W) was the first to use the Mudarabah (silent partnership) in trade with a rich women named Khadijah (who later became his wife). At the time, Muslims used to practice Musharakah (full partnership) when operating large commercial enterprises under a profit/loss sharing principle. In addition, Muhammad made it permissible for people to use sale on credit (bai salam) which was to finance consumption or production without usury and he encouraged Muslims to provide benevolent loans  (Quard Hassan). The ongoing Islamisation of Arabic countries meant that Sharia rapidly spread to both Muslims and non- Muslims at this time.

After the death of Muhammad (S.A.W) in 632AD, a great expansion of Islam occurred throughout the Arabic states and in large parts of the non-Arab world. The Islamic state in this ‘golden age’ was dominant in three continents, Asia, Africa and Europe. The Islamisation of economic systems during the four centuries following Muhammad (S.A.W)’s death reached Morocco and Spain to the west, India and China to the east, central Asia to the north and Africa to the south. The extension of Islamic tools of finance is also indicated by historical records of contracts registered between businessmen at the time, including Mudarabah and Musharakah. Islamic finance practices continued largely unchanged until the beginning of the 19th Century.

From the nineteenth century, nearly all Muslim countries fell under the control of the Western colonial powers (France in North Africa, Britain and France in the Middle East, Britain in the Indian sub-continent and Britain and The Netherlands in South-East Asia), effectively dividing the Islamic world into many small states.

By the mid nineteenth century almost all Muslim-controlled areas fell to the Western colonial powers and thus the existing financial scheme which complied with Sharia was effectively replaced by the capitalist system. From then until the second half of the twentieth century, most Muslim economies were dominated by the economic traditions and systems of Western Europe. However, while commercial banks, insurance companies and other types of intermediary firms employed conventional methods of finance (mostly as braches or agents of institutions in the colonizing country), Islamic methods of finance were still often practiced between individual Muslims.

With the independence of the Arabic countries from the colonial powers by the second half of the twentieth century, many Islamic economies also became more independent. As a result, Muslim economists started reconsidering the application of Islamic finance into a formal banking industry. The first attempt to establish an Islamic bank was in 1971 when the Egyptian government established the Nasser Social Bank. This bank provided a number of Islamic financial products, including interest-free loans to the poor, student scholarships and small business credit on a profit/loss sharing basis. This was followed by the Dubai Islamic Bank in 1975 and subsequent rapid expansion.

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