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ISLAMIC DEVELOPMENT BANK. The Islamic Development Bank is a unique aid institution, as all its funding is on an interest-free basis using financing techniques which are permissible under sharI `ah. It is a development assistance agency rather than a charity or a commercial bank, but, given that overheads are not fully covered, there is an element of subsidy in much of its funding. The paid-up capital in early 1993 of over two billion Islamic dinars was provided entirely by the governments of the Muslim states. An Islamic dinar, the unit of account, is equivalent to an International Monetary Fund Special Drawing Right, which was worth approximately U.S. $1.45.

Saudi Arabia subscribed over a quarter of the initial capital, and the bank is based in Jeddah, the kingdom’s main commercial center. The other major Arab oil-exporting states-Libya, Kuwait, and the United Arab Emirates-have substantial shareholdings and collectively enjoy majority voting rights, although decisions are not usually taken in this way. There are forty-five states which participate in the bank, all with either predominantly Muslim populations or substantial Muslim minorities, such as Uganda. Pakistan, Indonesia, and Malaysia are the largest non-Arab subscribers, but Turkey has been much involved with the bank, and even Iran has joined in spite of its political differences with several Arab states.

Following agreement by the member states of the Organization of the Islamic Conference, the Islamic Development Bank started operating in 1975. Much of its initial funding was trade related and short term in nature. As a result of the quadrupling of oil prices in 1974, many Muslim countries had difficulty in financing their oil imports and were in severe balance-of-payments difficulty. The oil-price boom may have helped the Muslim members of the Organization of Petroleum Exporting Countries (OPEC), but it created problems for the more-populous Muslim states. One obvious solution was for the Islamic Development Bank to provide bridging finance, which would help both petroleum importers and oil exporters.

Using the principle of murabahah (resale with specification of gain), the bank purchased the oil or petroleum products on behalf of the importing country, which repaid at a markup, usually within eighteen months. The markup was well below commercial rates of interest and in line with the terms of concessionary finance from such institutions as the World Bank. As the repayments were denominated in Islamic dinars, this imposed an additional local currency burden on countries whose exchange rate was depreciating. This was less of a problem in the 1970s, when most deficit countries had strict exchange controls, but with economic liberalization and market-determined exchange rates, the costs of hardcurrency repayment have risen.

The attraction of murabahah trade finance is that the credit is revolving, and the bank can get its money back. As the bank is not a deposit-taking institution, and cannot borrow conventionally in international financial markets, its resources are limited to the paid-up capital which its members are prepared to contribute. If disbursed funding is not repaid and becomes bad debt, the bank will soon run out of resources to finance new initiatives.

The Islamic Development Bank has therefore been very cautious about long-term equity participation through musharakah (profit-and-loss “partnership”), and there has been little mudarabah (silent or limited) partnership finance in which one partner provides finance and another entrepreneurial or management skills. The problem is how to disinvest, especially in the poorer Islamic countries which lack stock markets. Equity participation has mainly been in government institutions, such as national development banks, or quoted companies, such as Jordan Cement.

Long-term interest-free loans have been provided for projects with a significant socioeconomic impact, usually involving infrastructural work, such as roads or irrigation schemes. Funding has also been disbursed for hospitals, schools, and other social projects. These advances are for periods of up to thirty years, with a service fee to cover administrative expenses. Over $750 million has been lended in this way, often in cofinancing involving other agencies, such as the World Bank or the various Persian Gulf Arab development funds.

Since the mid-1980s the Islamic Development Bank has concentrated much of its funding through installment sales and leasing (ijarah). Both methods of financing are permissible under shari `ah law. By 1990 over $600 million had been advanced for the leasing of equipment in sixty separate deals, and a similar amount had been offered for installment sale. Usually these arrangements cover a five-year period, although the bank is very flexible over the terms it is prepared to negotiate.

The bank has made considerable efforts to support the poorest Muslim countries, such as Bangladesh, Mali, and Niger, but finance is only one of many development constraints which these states face. The identification of projects with any potential in such countries is far from easy, and the local government officials are either unable or unwilling to produce well-conceived applications for assistance. The Islamic Development Bank, like other international agencies, has moved into the area of technical assistance in project design and implementation. Often such work is tendered out to specialized consultants, and the bank follows a highly professional approach to such matters, seeking independent external advice if necessary. It has adhered closely to its articles of association and not succumbed to political pressures.

In recent years the bank has taken tentative steps to harness new capital, develop internationally acceptable Islamic financial instruments, and build a closer relationship with the Islamic commercial banks. It has the potential to serve as a central bank for these commercial institutions. The Islamic banks portfolio was launched in 1987 in order to attract funds from the Islamic commercial banks and provide them with a safe yet profitable liquid instrument which they could hold. Over $65 million was subscribed, the money being used to finance Islamic trade on a murabahah markup basis with the profits shared according to muddrabah.

In 1986 agreement was reached to establish a Unit Investment Fund, and after three years of study and consultation with shari’ah lawyers the fund became operational. The Islamic Development Bank, acting as muddrib (manager) for the funds provided by Islamic commercial banks, invests both in Islamic countries and international equity markets. Shares can be purchased in London, New York, and Tokyo, but the investment must be in companies whose activities are acceptable to Muslims (halal). Electronics and communications companies are acceptable, for example. A brewery or other company engaged in the manufacture or sale of alcohol is clearly not.

Further initiatives are being planned. The Islamic Development Bank has examined the feasibility of an export-credit insurance scheme to encourage trade between Muslim countries and the creation of a multilateral Islamic clearing union. Growing interest exists in the republics of the former Soviet Union with majority Muslim populations. Some of these are expected to become shareholders of the bank, making them eligible for Islamic financial assistance. The Islamic Development Bank has become a well-established institution which is respected in international banking circles. Much has been achieved, and its role is likely to grow in the years ahead, both in terms of geographical coverage and in the range of Islamic financing facilities provided.

[See also Banks and Banking; Economics, article on Economic Institutions.]


Iqbal, Munawar. Distributive Justice and Need Fulfillment in an Islamic Economy. Leicester, 1988. A Muslim view of poverty and development problems.

Meenai, S. J. The Islamic Development Bank: A Study of Islamic Cooperation. London, 1990. Comprehensive, if somewhat uncritical, account of the Bank’s first decade.

Wilson, Rodney. Banking and Finance in the Arab Middle East. London, 1983. The Islamic Development Bank is examined in chapter four and compared with Arab development agencies in chapter seven.

Wilson, Rodney. “The Islamic Development Bank’s Role as an Aid Agency for Moslem Countries.” Journal of International Development 1.4 (October 1989): 444-466. Quantifies the Bank’s activities. Uzair, Mohammad. “Central Banking Operations in an Interest-Free Banking System.” In Monetary and Fiscal Economics of Islam, edited by Mohammad Ariff. Jeddah, 1982, pp. 211-236. Relevant for the wider role that the Bank is seeking to play in relation to Islamic commercial banks.


Azhar Niaz Article's Source: http://islamicus.org/islamic-development-bank/

  • writerPosted On: June 21, 2014
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