What Was the Motive to Set Up Islamic Banks and What Actually Happened?

Author Credit:This blog is adapted from an article by Muhammad Rizwan-ul Haque, Founding Chairman of Dawood Family Takaful, CEO of an Investment Bank, and Director of a Trust. The original article was published on July 3, 2015.

Introduction

Islamic banking was established with a noble and sincere objective: to provide Muslims with a financial system free from Riba.

Since conventional banking was based on interest, scholars, economists, and financial experts began working on an alternative model around 40 to 50 years ago. Their goal was to convert conventional banking practices into structures that could comply with Islamic principles.

However, after decades of experience, an important question must be asked: did Islamic banking achieve its original purpose, or did it gradually become too close to the conventional model it was meant to replace?

The Original Motive Behind Islamic Banking

The original motive behind Islamic banking was to create a financial system that avoided interest and followed the guidance of the Qur’an and Sunnah.

The intention was not merely to change the names of products. The aim was to develop a fair, ethical, and Shariah-compliant system that would encourage real trade, partnership, risk-sharing, and productive economic activity.

In its ideal form, Islamic banking was expected to support socioeconomic justice and provide an alternative to interest-based finance.

Where Did the Problem Begin?

According to Muhammad Rizwan-ul Haque, the problem began when Islamic banking adopted certain features of the conventional banking model.

In an attempt to make Islamic banking workable in the modern financial system, some compromises were made. These included benchmarking

Islamic financial transactions to interest rates and relying heavily on Murabaha-based financing.

These measures may have been accepted as temporary steps, but over time they became deeply embedded in the Islamic banking system.

The Issue of Liquidity Placement

Islamic banks were successful in attracting deposits because many Muslims wanted to place their money in a system that claimed to be Shariah-compliant.

However, once these deposits increased, Islamic banks needed ways to deploy this liquidity.

Instead of moving strongly toward partnership-based modes such as Musharakah and Mudarabah, many Islamic banks relied on structures that closely resembled conventional financing in economic outcome.

This created a major concern: the system was Islamic in form, but not always Islamic in substance.

Temporary Measures Became Permanent

The original expectation was that certain compromises would be used only as a transitional arrangement.

It was hoped that, with time, Islamic banks would gradually reduce their dependence on interest-rate benchmarks and debt-like structures. They were expected to move toward genuine Islamic modes of finance such as Musharakah and Mudarabah.

However, after decades of practice, this shift has not happened at the required level.

Instead, many Islamic banks continue to rely heavily on the same transitional tools.

The Concern With Murabaha and Interest Benchmarking

Murabaha is widely used in Islamic banking today. While Murabaha can be valid under certain conditions, the concern is that it has often become the dominant financing mode, replacing the broader Islamic vision of risk-sharing and real partnership.

Similarly, when Islamic financial transactions are benchmarked to interest rates, the difference between Islamic and conventional finance becomes less clear to ordinary people.

If the pricing, risk profile, and economic result are similar to conventional loans, then the transaction may appear Islamic in legal form but questionable in spirit.

Has Islamic Banking Moved Away From Its Goal?

After 40 to 50 years of Islamic banking experience, Muhammad Rizwan-ul Haque argues that the industry has not moved far enough from the conventional model.

Although Islamic banks are making significant profits around the world, many have not given up the two practices originally viewed as temporary: interest-rate benchmarking and heavy reliance on Murabaha transactions.

This raises a serious question about whether Islamic banking has truly fulfilled its original mission.

The Bigger Economic Concern

The article also raises a broader criticism: both Islamic and conventional banks may become obstacles to real economic activity if their operations are not connected to productive business, employment, and social justice.

A financial system should help create goods, services, jobs, and fair opportunities. If banking mainly supports debt-like transactions and profit extraction, it may contribute to unemployment, inflation, poverty, and inequality.

Islamic finance was meant to offer a better path — one rooted in fairness, responsibility, and real economic contribution.

Returning to the Source

The solution, according to the article, is to return directly to the guidance of the Qur’an and Sunnah.

Rather than continuing to modify the conventional banking model and rename it Islamic, the Muslim world needs to reflect deeply on the original principles of Islamic economics.

The goal should not be to make conventional finance look Islamic. The goal should be to build a financial system that genuinely reflects Islamic values.

Conclusion

Islamic banking began with a sincere and noble purpose: to provide a Riba-free alternative to conventional banking.

However, over the past several decades, the industry has faced serious challenges. Interest-rate benchmarking, excessive reliance on Murabaha, and the limited use of true Musharakah and Mudarabah have raised questions about whether Islamic banking has remained faithful to its original purpose.

The way forward is not merely to defend existing structures, but to honestly review them.

Islamic finance must reconnect with its deeper mission: promoting real economic activity, justice, partnership, risk-sharing, and social balance.

Only then can Islamic banking move beyond form and become truly Islamic in substance.

Credit: This blog is adapted from the article by Muhammad Rizwan-ul Haque, Founding Chairman of Dawood Family Takaful, CEO of an Investment Bank, and Director of a Trust.