This paper aims at taking stock of the developments in Islamic banking over the past two decades and to identify the challenges facing Islamic banking to remain viable, to meet the growing competition and to develop and prosper. The practice of Islamic banking as it developed during our times has four main manifestations:

1. Banks in those countries where efforts are being made to restructure the entire banking system along the Islamic lines. These include Pakistan, Iran and Sudan.
2. Islamic banks in the private corporate sector.
3. Islamic Financial Institutions other than banks in some Muslim as well as non-Muslim countries and
4. Islamic banking practices undertaken by some conventional commercial banks and non-bank financial institutions.

This study focuses on the problems and challenges facing Islamic banking in the private corporate sector in a mixed environment. That comprises the bulk of Islamic banking. An attempt has, however, been made to make some observations, wherever possible, regarding institutions working in other environments.

The methodology used for this research is both analytical and empirical in nature. For the analytical part, the existing literature was thoroughly surveyed. A comprehensive list of issues relevant for the future of Islamic banking was prepared. A questionnaire based on these issues was mailed to 100 scholars, bankers and shari’ah experts all over the world. Out of these, 60 filled and returned the questionnaire. The perception of these experts on various problems facing Islamic banking is summarized in Annexure-I. The results of the questionnaire have not been fully analyzed yet. However, the authors benefited from these responses in formulating the major challenges facing Islamic banking which have been discussed in the paper.

For the empirical part, an attempt was made to collect statistical data relating to the main activities of Islamic banks and analyze it using various statistical techniques. However, this effort was severely constrained by the quantity and quality of available data. Details about the sources and quality of data are described in Annexure-II. Every attempt has been made to collect data from all possible sources and reconcile it so that it could become consistent as far as possible. Since the quantity of data was also limited, an attempt was made to get the maximum mileage out of the available information. In some cases, the study is confined only to a “snapshot” of the latest position, in other cases, it attempts to provide comparative statics. All this is due to non-availability of a consistent and sufficiently long time series which is necessary to carry out any in depth evaluation of Islamic banking during the last two decades. Where generalizations on broad features were to be made, the technique of pooling time series and cross-section data has been used because this technique minimizes the impact of inter-bank and inter-temporal variations. It is believed that these efforts would enable us to draw some statistically meaningful results, at least in general terms, if not with exact magnitudes.