Essentials of Islamic Finance MBA (M) Topic: RECENT HISTORY OF INTEREST BASED BANKING

Instructors name: Sir. Farhan Mehboob.

Group Members: Maliha Ahmed (3123) Ahmed Butt (3287)

History of banking Banks were established in 3000 BC and they were in the form of religious temple. In banks money, any precious item, gold, silver etc and deposited so that it remain in safe and temples were known to be a safest place. Financial innovations are taking place from recent years they are looking forward to enhance their profitability and investments. The interest based banking system was first established many years ago in Europe, by goldsmiths. These goldsmiths keep assets of the people, as people want it to be in safe place and in return give them the receipt, in which value of that asset was written. This means those who have that receipt could claim the written assets. As the time passes people realizes that the receipts are accepted anywhere in terms of payments of good and they found it easy to handle. That receipt is said the first bank money. On most of the banks people do not claim their gold back and circulate the receipt. Goldsmith use to keep little amount of the valuable with them in terms of their fees for keeping the valuable in safe place. That is now a day is known as reserve ratio. This way gradually and slowly interest based banking started. What is bank? According to Merriam- Webster online dictionary banking is an establishment of custody loan or exchanges and it also facilitate transmission of the funds of bank. In simple words banking is a system which involves banks, bankers and the customer in which financial aid and investment is provided. In order to avail these services

customer has to pay some amount. This is decided according to the interest percentage which is set by the government.

History of Federal Reserve Bank Inc. In 1066 AD King Williams found an England monarchy. He planned to have a corporation which will deal with the trade so that the kingdoms wealth would be enhanced. Trading was started in the very next year. At the time of William III in the year 1694 was granted with the royal chartered. The grant was to regularize the monarchy finances. The scheme was to create bank funds with the perpetual interest. Fractional reserve banks than created a scheme of loaning the businesses that would never be repaid. After that months and years passes. Many transactions and loans were given to US Bank which was unpayable. The US Government than got to know about their tips and tricks and announces for war with the huge capital. US did everything to remove the influence and control of British. But they failed. Times changes and Thomas Woodrow was elected. Under his leadership US receives the federal reserves. After that US was free from the slavery of British. Federal Reserve Bank was created in the year 1913 by Federal Reserve Act. Its objective was to serve as a formal lender of last resort for the banks at the time of liquidity crisis. It has seven board members of the governing bank. It was opened for business in the year 1914. Federal Reserve notes were provided by the Congress within an elastic supply of currency. The note was to be issued to the Federal Reserve Bank for an adequate transmission of notes to the financial institutions according to the need of the public. Central banking system established the 12 Federal Reserve Bank regionally.

State bank of Pakistan It is legally under the authority of state bank of Pakistan to increase or decrease the percentage of the interest. If the percentage is high there is more inflation and vice versa. It is high when the countrys export is less and import is high. The objectives of state bank of Pakistan are Maintain and stable the growth Broadening access to financial sector Exchange rate Reserve management Strengthening the payment system

Currently state bank of Pakistan announces that because of the monetary loans we have taken from IMF we need to increase our interest rate and which is now at 14%. This high percentage will increase the rate of inflation. As we are already suffering from it. ALLAH forbade Riba/ Interest for us. HE has clearly mentioned it in HIS ayaats that those who eat riba will not be forbidden. Muslims are asked to fight against the one who eat riba. Unfortunately we all have forgotten the teachings of our religion and rubbed the concept of riba from our lives.

Interest It is a fees paid to someone on the borrowed assets. Assets can be of any thing that is tangible and valuable. Interest Rate It is a rate which is given by a borrower to the lender on behalf of using the asset. From the past two centuries interest is changed and varied by the National Government. As it shows a wide variation from 1989 to 2009 that is from . 25% to 19%. They vary for many reasons like political issue, deferred composition, alternative investments, inflation, liquidity preferences and taxes. Types of interest rate 1. Simple interest 2. Compound interest a. Fixed and floating rates 1. Simple interest is about the unpaid principle amount

2. Compound interest increases with the increase in time period.

This interest can be fixed or floating. Banks uses compound interest because they earn more profit by using this. Not only banks but the customers are happy with this banking system.

Journey from barter to payment system Basic thing with which banks run is money. Barter is actually the origin of our civilization. If we do not use money we would have to produce goods for ourselves and then trade it with what we dont produce. The development of technology replaced this system with money and established a market in which all the goods are available and people have to buy directly from the market. Technology now a day is so revolutionized that it has introduced online banking, mobile banking, wireless accessibility and other improved and advance systems.

Products and services provided by interest based banks The products and services provided by the banks are more or less same. Here are some common and general services: 1. Saving accounts 2. E-banking 3. Mobile banking 4. SMS Alert 5. Term deposit 6. Current account 7. Basic banking account 8. SME financing and many more. Saving accounts are the simple saving bank accounts. Helps customer deposit their funds, capital and assets. Electronic banking includes
ATM

VISA card Pay utility bills Telephone banking Cheque free banking Internet banking

PEST Analysis of Banks

List of some interest based banks in Pakistan 1. Citibank 2. Barclays bank 3. Standard chartered 4. ABN AMRO 5. HSBC

Recent history of interest based banking:

Islamic banking was introduced in Pakistan in 1979. When govt. when govt. of Pakistan converted NIT in to IC (investment corporation). In the year 1974- the interest based baking was considered illegal in Pakistan, taking activities of private banking away from western bank and govt. financing operations as well. Since then number of banks and other financial institutes were emerged which offer products in ways that comply with the Shariah. In 1988- the rich Gulf Arab states that Pakistan and other Muslim nations customer withdrawal their investments from western firms. According to him the interest based banking help concentrate the wealth in the hands of minority. In the year 2001- 60% of Rs. 1276 billion was accounted for small depositor in the banks of Pakistan. More than 87% invested in interest based govt. schemes. These investors were always relied on fixed and guaranteed return. In 2003- the Shariah Applet Bench of Pakistan ordered all banks to change their interest based banking system to Islamic system. In year 2004- the issue of interest free banking came under the consideration but by then financial and economical influences had produced number of local and national banks which were established along the lines of interest based banks.

2005 was the year of initializing the Islamic banking system in many countries through private investors. There was said to be a Islamic banking system but it wasnt actually the conventional interest based banking was continued side by side.

In the year 2009 in order to not to rely on interest based baking system 6 of the Islamic banks of Pakistan decided to set up an Islamic interbank price market. According to them, religious scholars and customers feel awkward about that because of Riba element in it.

Current situation 2010

Islamic bank is being promoted by State Bank of Pakistan and interest based banking side by side. Govt. is focusing on the continuous investment in certain industries. It is now realized that interest based economy is the biggest reason of inflation worldwide as it was based on lending and led collapse of banking sector in few decades. As Pakistan is the second largest Muslim state it is planning to increase its Islamic banking system in the future years. Transaction will be than based on the exchange of assets rather than interest. Islamic law requires that profits should be derived form ethical and socially responsible investments. Pakistans banking gaining is on the 3rd position on the IMF chart. The interest of the foreign banks in Pakistani banks is also rising.

Advantages of banks and banking 1. Transaction cost will be eliminated- this means if we go outside the country we just dont need to worry about the money change your bank will help you. 2. Money security 3. Money multiple by the profit added or given to us par month or par annum (as decided) 4. Money is managed and invested in a welfare business. 5. No risk of having loss in business. 6. Many services and products are given to the customer when he deposits his capital to the bank.

Disadvantages of Banks and banking

1. Easy installments are so called

2. Bank charges more than the items actual price. 3. Interest causes inflation. 4. High interest means high taxes. 5. It is against the Shariah. 6. They have hidden policies in their contracts.

The US stock market drops is commonly called a predictor of recession this mean from here the recession was started. According to IMF the recession period is a cycle which comes in every 8 to 10 years. During the IMF terms around three recessions are passed in last three decades. There are many causes of recession like currency crisis, financial crisis, under consumption, war etc. but the most important of all is the increment of interest rate. Let us understand it with a simple example that a man and his family bought a house on a lease from a bank. Bank leased them the house in a so called easy installments. Then all of a sudden inflation strikes the economy and a man was unable to pay the installments which he was supposed to pay every month. He decided to leave the house and give it back to the bank. Same thing was done by so many people because of the same inflation and unaffordibility reason. The bank that invested a handsome capital to make the house beautiful and made attractive decorations in it bears a great loss in this way. This is how interest based banking welcome recession to some extent.

Allah has forbidden interest and strictly told Muslims to avoid it. Allah stated in Quran that Muslim should war against those who use and eat interest (Riba). Some of the Quran ayaat are shown below in which Allah is asking people to leave interest (riba).

References

www.scribd.com www.wikipedia.com www.ourbeacon.com www.mortgages.co.uk> interest rate www.users.bart.nl

Book used for the report: A History of interest rate by Richard Eugene