Recent global financial crisis has highlighted the problems in the current financial system. Some of the analysts have even termed it as the downfall of the capitalism and interest based economy driven by ‘greed’ and has acknowledged the need of a new financial system. One interesting development in this whole scenario was the relative stability of Islamic Financial Institutions (IFIs). In the last decade, IFIs have witnessed an impressive growth and have begun to make an impact on the current financial setup. This paper aims to highlight the basic foundation of Islamic financial system and the development of different markets and institutions. It will then point out certain issues and challenges facing the Islamic Financial Institutions.
The history of Islamic Financial system goes back to 1,000 – 1,500 AD, during which the Middle Eastern tradesmen would engage in transactions based on Shariah. During that time, the Ottoman Empire Arabs had good trade relationships with the Spanish, and they established their financial systems without interest, based on profit and loss sharing basis. As time went by, Middle Eastern and Asian regions became important trading partners for European companies such as the Dutch East India Company, as a result of which European banks started to spread their branches in these countries, which typically were interest-based. Thus the conventional financial institutions became more dominant as Western countries started to play an important role in world economy. Although, credit unions and co-operative societies based on profit and loss sharing system continued to exist, their activities were focused on very small geographical areas.
Islamic Banking Practice, Early Initiatives:
Islamic Finance started to grow radically in the mid 1980s when the first financial company based on Shariah, Mit Ghamr...