'Islamic banking' is now a widely-known term in both the Muslim world and the West. It denotes a form of banking and finance which attempts to provide services to clients free from 'interest'. The proponents of Islamic banking argue that interest is riba and, as such, is prohibited under Islamic law. This attitude towards interest has led several Muslim scholars and financiers to find ways and means of developing an alternative banking system which would comply with the injunctions of Islamic law, in particular, the rulings related to the prohibition of riba.
Since the mid 1970s, Islamic banks have been growing at a surprisingly fast rate. These banks were established not only in countries where Islam is the majority religion like Egypt, Jordan, Sudan, Bahrain, Kuwait, United Arab Emirates, Tunisia, Mauritania and Malaysia, but also in the United Kingdom, Denmark and the Philippines, where it is a minority religion. An international Islamic bank, the Islamic Development Bank, whose shareholders are members of the Organisation of Islamic Conference (OIC), acts as the sponsor of Islamic banking and finance in the wider Muslim world. This is in addition to the major efforts made in the early 1980s by Pakistan and Iran to transform their entire financial systems to interest-free ('Islamic') systems.
The theory of Islamic banking, which has been in the process of development since the 1950s, maintains that Islamic banking is interest-free banking based on the concepts of muḍāraba and mushāraka, that is, Profit and Loss Sharing (PLS). Islamic banking theorists and the Muslim legists who contributed to this theory interpreted riba as 'interest' and 'predetermined return on capital', particularly financial capital. They believed that a reinterpretation of the traditional definition of riba as developed in Islamic law was out of the question, based on the idea of the immutability and permanence of sharī'a rules.
By interpreting riba as interest, Islamic banking theorists are following the early concept that any benefit which accrues to the lender in a loan is riba. Based on this view, any increase (nominal or real) in a loan which accrues to the creditor would be riba. The acceptance of this interpretation would not allow an Islamic bank to accept any predetermined return on capital in a loan/debt transaction. To put this interpretation into practice, Islamic banks would have to reject, at least in theory, all the transactions