Islamic Banking is banking that complies with the Islamic law. According to the Islamic/ Sharia law:
- Interest is prohibited.
- Investment in business that deals with goods and services considered ‘haram’ is prohibited. Example: pork, alcohol, gambling, pornography etc.
- Gambling or speculation has to be minimised. Hence, it rules out investment in derivatives, options and futures
(Read: Derivatives, Options and Futures Explained)
Modes of Islamic banking or finance
Islamic banks do not charge interest. They operate on the basis of risk sharing. Some modes of Islamic banking are:
- Mudarabah: In this, depositors provide funds to the banks. The bank invests the money into a business. The profit earned from the business is shared between the depositor and the bank in a pre-determined profit sharing ratio. But, the loss is borne by the bank only. The bank provides management expertise to run the business. Unlike conventional banks, no fixed rate of interest is given to the depositor. (1)
- Murabaha: Let’s say, Vishal wants to buy a car worth Rs.500000. He does not have money. He can approach a bank. The bank buys the car at Rs.500000 and sells it to Vishal at Rs.550000. Vishal will pay Rs.550000 to the bank in fixed instalments. This is Murabaha. Murabaha is one of the most common modes used by Islamic Banks. The mechanism of Murabaha is that the bank purchases the asset as per requisition of the client and sells him on a cost-plus-profit basis. (2)
- Ijara: Under Ijara, the bank leases out assets like plant, motor vehicle etc. for a fixed period of time and payment. Leasing is basically a contract between two parties: the owner of the asset (lessor) and the user of the asset (lessee). The user of the asset pays money to the owner of the asset. An example of leasing is a rental agreement, in which the tenant pays rent to the owner of the house.
- Takaful: Takaful is a type of Islamic insurance, where members contribute money into a pooling system in order to guarantee each other against loss or damage. Takaful insurance companies were introduced as an alternative to commercial insurance companies. Commercial insurance companies go against the interest, gambling, uncertainty principles, that are outlawed in Sharia. (3)
Evolution of Islamic Banking
An article in Scroll describes the evolution of Islamic Banking.
The first successful example of an Islamic Bank was a financial institution called Tabung Haji in Malaysia. It was set up in 1963, in response to a high demand of interest-free money for Hajj pilgrimage. Tabung Haji came into being with a total of 1,281 depositors which increased to 8,67,220 depositors and with deposits over one billion Malaysian dollars.
This paved the way for the creation of more Islamic banks especially in Egypt where small-scale Islamic Banks already existed. The success of these banks led to the formation of the Naseer Social Bank in Cairo in the year 1972.
In the same decade, an International Islamic Bank was formed. It was called Islamic Development Bank. It was set up to promote the economic development of the Muslim community in accordance with the Shariat laws.
While Islamic Banking is prevalent and is common in Islamic countries, there are some non-Islamic countries that have opened “Islamic windows” in conventional banks. China, United Kingdom, Germany are some of the countries that offer Islamic windows.
The United Kingdom was the first non-Islamic country to permit a complete shariat compliant bank called the Islamic Bank of Britain to operate.
Criticism of Islamic Banking
- According to a blog by the Middle East Media Research – the fundamental practice of charging interest is not truly eliminated in Islamic banking but is merely relabelled and disguised using various legal tricks. Example: In Murabaha, the profit markup charged by the bank in selling an asset is nothing but interest in disguise.
- Also, the article in Scroll mentions a World Bank paper that states that conventional banking and Islamic banking methods are very similar to each other. There is no significant difference between the two.
- Another criticism is that some Islamic bankers invest in goods and services that are ‘haram’. They find their way to manage and get around the system to get a shariat complaint certificate.
- In the Indian context, Jagannathan writes– If Islamic banking is introduced, it will create financial ghettoes in the same way the community is being ghettoised in cities.
- Some people also feel that a bank that is established purely on religious lines have no place in a secular country like India.
Islamic Banking in India
The Reserve Bank of India has decided not to pursue a proposal for introduction of Islamic banking in the country.
In late 2008, a committee on Financial Sector reforms, headed by the former Raghuram Rajan, stressed on the need to examine the issue of interest-free banking in India. The rationale was to bring people who do not access banking services due to religious reasons, in the banking market.
An inter-departmental group (IDG) was set up to examine the legal, technical and regulatory issues for introducing interest-free banking in the country. This was done on the instruction of Central Government.
In February 2016, the RBI sent a copy of the IDG report to the Central Government. It recommended that an ‘Islamic window’ should be opened in conventional banks. This would pave the way for the gradual introduction of sharia-complaint banking.
Recently, the RBI has decided not to pursue Islamic banking in India. This decision was taken after considering the fact that equal banking opportunities are already available for all citizens.
In 2014, the Government had launched the Pradhan Mantri Jan Dhan Yojana to provide a bank account to every household in the country.
(Read: Financial Inclusion and Pradhan Mantri Jan Dhan Yojana)
To be sure, the introduction of Islamic banking has many advantages. It will help us to attract financing from Gulf countries. However, the Indian banking laws will have to be amended so as to incorporate the provisions relating to Islamic banking. For example, the Banking Regulation Act requires payment of interest. Interest is ‘haram’ in Islam.
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References:
What is Islamic Finance? – Scroll