Theoretical Foundations of Islamic Banking

Banks are the most important financial institutions in a modern economy. They perform some very important functions for society and in this process significantly influence the level of economic activity, the distribution of income and the level of prices in a country. Although initially the major function of banking was to mobilize savings and transfer them to entrepreneurs, over time they have come to perform a number of other functions as well. In addition to offering their services for safe custody of money and other valuables, they also offer current account facilities, easy transfers of money, letters of guarantee, payment of utility bills, and loans for consumer durables and investment. As a result of developments such as credit cards, automated teller machines (ATMs), repurchase accounts, and so on, it has become very easy to make payments through banks. Therefore, in a modern economy, a very large part of current incomes are deposited with the banking system. Due to the facilities mentioned above, people do not need to physically withdraw their money nearly as much as they used to. As will be discussed later, this phenomenon enables the banks to ‘create’ money on their own. This feature increases banks’ influence over an economy. The functions that the banks perform are very important, and an Islamic economy cannot operate without these functions. Consequently, Islamic scholars have dealt with the theoretical foundations of banking activities with a view to finding alternatives.