ISLAMIC FINANCE

What If Colonialism Never Disrupted Islamic Banking?

Discover the sophisticated Islamic financial system that existed centuries before European banking and how colonialism erased it. A mind-bending look at the banking history you were never taught.

Photo by Raimond Klavins / Unsplash

Here's a question that might rewire how you think about global finance:

What if the Islamic world had invented modern banking first—and we just... forgot?

Not "what if" as speculation. "What if" as in: they actually did, and then something happened.

The Islamic Financial Services Industry today is worth $3.88 trillion. It's growing at 10% annually. And nearly all of it is built by taking Western financial products—bonds, insurance, mortgages—and reverse-engineering them to comply with Islamic law.

But:

For about 800 years, the Islamic world had its own sophisticated financial system. Banks. Checks. Bills of exchange. Securitized government debt. Venture capital partnerships.

Then colonialism happened. And that system didn't evolve. It was erased.

The World's First Check Was Written in Baghdad

Let's start with something concrete.

The English word "check" comes from the Arabic word sakk. The first recorded check in history was drawn by a sarraf (money-changer) in 10th-century Baghdad.

By the 900s CE, the Abbasid Caliphate had developed:

Suftaja: Bills of exchange that let merchants transfer funds across thousands of miles without moving physical currency. A trader in Basra could write a suftaja payable in distant Samarkand.
Hawala: Trust-based remittance networks that moved value through agents rather than cash. (These still operate today—Western Union is essentially a formalized hawala.)
Mudaraba: Profit-sharing partnerships where investors provided capital and entrepreneurs provided labor. Profits split by agreement; losses borne by investors only.
Jahbadh banking: Full-service bankers who accepted deposits, extended credit, issued payment instruments, and maintained multigenerational family firms with agent networks across the caliphate.

A contemporary observer in 10th-century Baghdad marveled: "What a sight to see a bill of exchange drawn in the enemy's country! If this is a source of pride, then the merchants are more powerful than the Viziers."

The banking firm of Joseph b. Phineas and Aaron b. Amram held the title "State Banker of Ahwaz Province." They accepted deposits worth millions of dinars. They charged around 30% annual interest.

Wait—interest? In Islamic finance?

We'll get to that. It's more complicated than you've been told.

The Partnership That Europe Copied

Here's where it gets interesting.

Abraham Udovitch, the preeminent scholar of medieval Islamic commerce, spent decades studying the mudaraba partnership structure. His conclusion, published by Princeton University Press:

"The mudaraba represents the earliest example of a commercial arrangement identical with that economic and legal institution which became known in Europe as the commenda."

The commenda was the foundation of Mediterranean trade finance. It enabled the Venetian and Genoese merchant empires. It's the ancestor of modern venture capital and limited partnerships.

And it appears to have been borrowed from Islamic practice through trade contacts.

The pattern repeats. The suftaja (Islamic bill of exchange) predates European bills of exchange by centuries. The organizational structures that enabled long-distance trade—agency networks, correspondent banking relationships, letters of credit—were operating in the Islamic world while Europe was still in the early medieval period.

S.D. Goitein's monumental study of the Cairo Geniza documents (a treasure trove of medieval commercial correspondence) reveals a credit-based Mediterranean economy spanning from Spain to India. Trade operated on credit and trust. Partnerships crossed religious lines. The system was expanding, formalizing, becoming more sophisticated.

It was evolving.

The Ottoman Innovation That Should Have Changed Everything

Fast forward to the Ottoman Empire, 16th century.

A fierce debate is raging among Islamic scholars. The question: Can you create an endowment (waqf) using cash instead of property?

Traditional waqf doctrine required permanent, non-consumable assets—land, buildings. Money seemed to violate this principle. You can't endow something that gets spent.

But commercial pressure was building. Merchants needed capital. The economy needed financial intermediation.

The debate pitted Qadi Çivizade (who called cash waqfs disguised usury) against Shaykh al-Islam Abu al-Su'ud, the Ottoman Empire's highest religious authority.

Abu al-Su'ud won. His argument: established custom and social necessity could legitimate innovations that served the community.

The institutional consequences were explosive.

By mid-16th century Istanbul, 46% of all endowments were cash waqfs. These institutions mobilized capital at scale. Waqf trustees lent to sarrafs (bankers), who lent to merchants and tax farmers. A secondary capital market emerged organically.

Then, in 1775, the Ottomans invented something remarkable: esham.

After the disastrous Russo-Turkish War, the empire needed financing. The solution: take annual tax revenues, divide them into shares (sehim), and sell those shares to investors for life-term payments.

This was securitization. Revenue-backed securities. The structural ancestor of modern sukuk.

Some scholars call esham "the world's first Islamic securitization." Whether or not that's precisely accurate, the point stands: the Ottoman financial system was innovating sophisticated instruments without Western templates.

The System That Was Evolving—Before It Was Erased

Here's what the trajectory looked like by the early 1800s:

Capital mobilization: Cash waqf institutions connected to sarraf banking networks, channeling endowment capital into commercial lending.

Government finance: Esham securities distributing revenue risk to investors rather than creating fixed debt obligations.

Commercial credit: Bay' al-wafa' (sale with buyback) providing secured lending; sarraf networks financing merchants and tax farmers across provinces.

Tradeable assets: Even guild-based usufruct rights (gedik) were evolving into liquid instruments—masters using certificates as collateral, trading them on secondary markets.

Legal infrastructure: Hanafi jurisprudence developing sophisticated mechanisms for accommodating commercial innovation. The principle that "widespread need assumes the status of necessity" enabled ongoing adaptation.

Islamic commercial law wasn't static. It was evolving toward greater accommodation of financial complexity—not through abandoning principles, but through sophisticated juristic reasoning about how principles applied to new circumstances.

The question "is this permitted?" was being replaced by "how do we structure this so it's permitted?"

And then came 1838.

How Colonialism Systematically Dismantled Indigenous Finance

The Anglo-Turkish Commercial Convention of 1838 (Balta Liman) abolished Ottoman state monopolies and set tariffs for European goods at 3%.

Contemporary historians describe it as delivering "the coup de grâce to Ottoman manufacturing."

But manufacturing wasn't the only casualty.

The capitulations system—originally granted from Ottoman strength to encourage trade—had become a weapon. European merchants gained exemption from local courts, local taxes, local law. Non-Muslim Ottoman subjects became "licensed dragomans" for European firms, eroding Ottoman legal jurisdiction from within.

Then came the debt trap.

By 1881, following sovereign default, the Ottoman Public Debt Administration (OPDA) was established. Its governing council included British, French, German, Austrian, Italian, and Dutch creditor representatives. The Ottoman state got one seat.

The OPDA employed 5,000-9,000 officials—more than the Ottoman finance ministry itself.

It controlled one-quarter to one-third of state revenue.

It absorbed the indigenous sarraf banking networks into European-controlled structures.

The trajectory:

1820s: Political executions of prominent sarraf bankers
1856: Imperial Ottoman Bank established with British capital
1863: Reorganized as Franco-British venture
1895: Liquidity crisis "eliminated many of its local competitors including several of the remaining Galata bankers"

In Algeria, the destruction was more direct. An 1843 French decree simply confiscated Islamic endowments (habous)—violating the 1830 surrender treaty that had guaranteed protection of Islamic institutions.

Up to 50% of agricultural land in pre-colonial Algeria was designated waqf.

Confiscation cut funding for religious institutions, schools, charitable services. It wasn't collateral damage. It was systematic dismantlement.

The Road Not Taken: What Organic Islamic Finance Might Look Like

Here's where we enter genuinely speculative territory—but speculation grounded in documented trajectories.

If the Ottoman financial system had continued evolving without European displacement, what might modern Islamic finance look like?

Banking without the debt-equity dichotomy

Contemporary Islamic finance imports Western categories: "equity" vs. "debt." Products must be classified as one or the other.

But the Ottoman system blended waqf endowment logic (perpetual capital, distributed returns), partnership structures (mudaraba), and secured credit (bay' al-wafa') without forcing them into separate boxes.

An organic evolution might have produced financial institutions that don't map onto "bank" vs. "investment fund" vs. "insurance company"—hybrid entities serving multiple functions through integrated structures.

Government finance without bonds

Esham distributed revenue risk differently than interest-bearing debt. Investors bore fluctuation risk; government avoided fixed obligations regardless of fiscal conditions.

Modern evolution might involve infrastructure financing structured as participation in specific project revenues—which contemporary sukuk attempts, though critics argue most sukuk are "conventional bonds with Arabic terminology."

Corporate structures without public stock markets

The gedik transformation—guild usufruct rights becoming tradeable financial instruments—suggests equity participation tied to productive capacity rather than abstract ownership claims.

Imagine "shares" representing operational involvement rather than passive claims divorced from the business itself. More like modern cooperatives or professional partnerships than publicly traded corporations.

Different governance. Different time horizons. Different scale limitations—but perhaps different stability.

Money backed by real assets

Historical Islamic practice included commodity-backed currency (gold dinar, silver dirham) but also accepted fiat-style paper instruments. The suftaja functioned as a medium of exchange independent of commodity backing.

A counter-factual Islamic monetary system might have evolved toward asset-backed fiat currency—government money backed by real assets following sukuk principles—rather than fractional reserve banking that creates money through credit extension.

Some contemporary scholars argue that fiat money created "out of thin air" violates Islamic principles. The debate never reached resolution because the trajectory was interrupted.

The Uncomfortable Question Contemporary Islamic Finance Doesn't Want to Ask

Here's the elephant in the room:

Modern Islamic finance is overwhelmingly debt-based instruments dressed in Arabic terminology.

The numbers are stark:

Murabaha (cost-plus sale), ijara (leasing), and tawarruq (commodity monetization) dominate Islamic banking
True profit-and-loss sharing (mudaraba, musharaka) represents less than 6% of Islamic financing despite being "the most authentic form of Islamic contracts" according to theoretical literature
Islamic banks avoid participatory contracts because they require long-term project financing with higher information costs
Scholars like Mohammad Nejatullah Siddiqi have documented that "the practice of Islamic finance significantly departs from its theory"

The result, according to recent peer-reviewed research: "Rather than an authentic Islamic model, a simplified version of Islamisation was opted as a strategy to operate within the capitalist hegemony by taking the conventional banking logic."

When you rebuild a financial system by retrofitting Western architecture, you inherit Western assumptions. The debt-equity dichotomy. The separation of investment from governance. The primacy of shareholder returns. The structure of central banking.

What might have developed organically—integrating Islamic principles into the architecture itself rather than bolting them onto a foreign framework—remains the road not taken.

Why This History Matters Now

You might wonder: Why does any of this matter? The past is past.

Three reasons:

1. It reframes the legitimacy debate

Contemporary Islamic finance faces constant criticism for being "conventional banking with Arabic terminology." Understanding that sophisticated indigenous alternatives existed—and were systematically dismantled—changes the conversation from "can Islamic finance work?" to "what was lost, and can it be recovered?"

2. It opens design space

If you think the only options are "conventional finance" or "Islamized conventional finance," your innovation space is constrained. Understanding that different architectures were evolving—hybrid institutions, revenue-participation securities, asset-backed money—opens possibilities that pure retrofitting forecloses.

3. It illuminates what "authenticity" might mean

The most authentic Islamic finance might not be the most literally compliant with classical texts. It might be finance that continues the evolutionary trajectory that was interrupted—juristic reasoning adapting principles to new circumstances, institutional innovation emerging from commercial practice, organic development rather than imitative reconstruction.

The Question Nobody's Asking

The $3.88 trillion Islamic finance industry is built on a foundation of absence.

Absence of the institutions that were dismantled. Absence of the evolutionary trajectory that was foreclosed. Absence of the architectural alternatives that might have emerged.

Contemporary practice fills that absence by importing Western structures and certifying them halal. It's not nothing—it serves genuine demand from Muslims seeking religiously compliant financial services.

But it's worth asking what it isn't.

What if Ottoman financial evolution had continued uninterrupted? What if cash waqf institutions had developed into indigenous Islamic banks without European displacement? What if esham had evolved into sophisticated sovereign finance rather than being replaced by conventional debt?

We can't know for certain. Counter-factuals are inherently speculative.

But we can know this: the road not taken was a real road. It was being traveled. It had direction and momentum.

Understanding that—really understanding it—might be the first step toward finding it again.

Disclaimer: The views expressed in this blog are not necessarily those of the blog writer and his affiliations and are for informational purposes only.