One of the most interesting developments in the field of international finance over the last couple of decades has been the development of Islamic banking.Although this form of banking has been followed for centuries it is only recently that it has caught the attention of the world, when flush with petro -dollars many Islamic countries in the Middle East started to promote Islamic banking in their respective countries.This move was prompted by the desire to run their nations according to the principles of 'Sharia.'
Contrary to popular perception, Islamic banking is not against the idea of a profitable return on an investment. It is just opposed to the idea of interest paid on deposits or any other form of pre- determined return, which is considered to be 'Riba' or usury.Additionally these banks seek to channelize investments into desirable business activities and investments in forbidden businesses such as alcohol, gambling and pork etc. are banned.
Islamic scholars have long accepted the idea of profit sharing for Islamic bank depositors and borrowers as a proper method of compensation.Today Islamic banking is already managing funds in excess of $200 billion and it is growing rapidly.
Amongst the dilemmas that Islamic banks face in an increasingly globalised economy with fewer and fewer controls on cross border foreign exchange movements is that in order to attract depositors they must be able to assure a certain minimum return over a given time period. Too low a rate of interest on long term investments in an inflationary environment may just not be acceptable to most people. More importantly they need to be viewed as independent financial institutions and not as extensions of their respective governments which may require them to finance their welfare programs at the expense of their depositors.
All interest free banks agree on the basic principles but individual banks differ greatly from each other.These differences are due to the differences in the laws of their respective countries, the objectives of the individual banks and also the degree of their interaction with other interest based banks. These factors have inhibited the growth of a truly international bank which is so important these days.These banks also seem to be lagging behind in providing several modern banking and financial products and services which are in demand.
Finally there is increasing criticism, often in the countries' of their origin itself,that the financial charges they receive from their borrowers is nothing but interest called by a different name.
In spite of these problems the size of this industry, fed with an unending supply of petro-dollars, is simply too large to be ignored.In fact it needs to be studied carefully and suitably strengthened to meet the challenges posed by modern banking methods so that it is able to discharge effectively the role assigned to it.