Islamic Banking in GCC: Emergence, Growth, and Prospects

1. History Of Islamic Banking

In the history of Islamic civilization, the notion of partnership and profit-sharing had been always more prominent than interest-based borrowing and lending since Riba (interest) is considered as ‘Haram’ (prohibited) according to the Islamic principles. However, these Islamic economic principles were forgotten after the rapid rise of the western model of financial intermediation and commercial banking in the post-industrial revolution era. Since the 1850s, almost all Muslim countries accepted laws and legal structures rooted from Western models since they were under direct or indirect pressure from the European countries. After the end of colonial period, although the foreign banks are nationalized in these Muslim countries, they were still run by following the Western style in a ‘neo-colonial’ system. But especially in rural and religious regions of the Islamic world, the people were skeptical towards these western financial institutions. In this respect, there was a strong need for the formation of a financial institution that watches over the Islamic principles or in other words that is interest-free. The first pioneering initiative for the enlargement of Islamic finance and banking happened in Mit-Ghamr in Egypt. Getting inspired from the German savings banks, the Mit-Ghamr Islamic Savings Bank founded by El-Naggar who eventually took the role as the Secretary-General of the International Association of Islamic Banks in the succeeding years. The Mit-Ghamr project collected savings from the rural sector through savings, investments and Zakat¹ accounts. Interest was not given to customers in the saving accounts, but they were authorized to withdraw their deposits when they need. Participants were also qualified to obtain small, short-term interest-free loans for fruitful motives. The money placed in the investment accounts could be withdrawn on a limited basis and were invested based on profit-sharing (Chachi, 2005). Wilson (1983) reported that: “The bank’s loans were used for different motives such as house building and repairs … Some loans were used to fund the acquisition of farm animals and fundamental upgrade to the irrigation systems as efficient water provision was absolutely necessary for a society rested solely on cultivation”. (Chachi, 2005; Molyneux & Iqbal, 2005) The Mit-Ghamr project that started in 1963 and continued until 1966 gained a big success in these short three years. In three years, the savings deposits increased from 25,000 Egyptian pounds to 125,000 Egyptian pounds. In a similar fashion, investment deposits more than doubled from 35,000 to 75,000 Egyptian pounds. The Mit-Ghamr project also had a zero-default rate by following a stricter and wiser loan lending policy. Despite its success, the Mit-Ghamr project was canceled due to political reasons in the following years. It is said today that this bank would have covered the whole Egypt by now due to its extreme success in its short life period if it was not canceled by the Egyptian authorities. Its extreme success created conflict with the local social authorities because they thought that Mit-Ghamr Islamic Savings Bank started to interfere with their own power. (Chachi, 2005) However, it proved that a financial institution governed by the Islamic principles was longed for and had a strong potential to be successful. After the abolishment of the Mit-Ghamr project, the first interest-free financial institution with the official title of ‘bank’ that is Nasser Social bank was founded again in Egypt in 1971. (Abedifar et al., 2015)