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Islamic Banking in India: Challenges & Way Ahead [Mains Article]

The RBI has now said that given the complexities of Islamic finance and various regulatory and supervisory challenges involved, and also due to the fact that Indian banks have no experience in this field, Islamic banking may be introduced in a gradual manner.
By IT's Mains Articles Team
November 14, 2017

Contents

  • What is Islamic or Sharia banking?
  • Rejection of usury: fundamental principle of Islamic banking
  • Then, how does a bank work without interest being charged or given?
  • Is usury the same as the conventional banking systems?
  • What is the rationale for Sharia banking?
  • Is Sharia banking restricted to Muslims alone?
  • Sharia banking globally
  • Introduction of Islamic Banking in India
  • Strong case for Islamic Banking in India
  • Difficulties in implementing Islamic Banking in India
  • Way ahead

Islamic Banking in India: Challenges & Way Ahead [Mains Article]

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GS (M) Paper-3: “Inclusive growth and issues arising from it.”

 

What is Islamic or Sharia banking?

  • Islamic or Sharia banking is a finance system based on the principles of not charging interest. The charging of interest is prohibited under Islam.

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Rejection of usury: fundamental principle of Islamic banking

  • The fundamental principle of Islamic finance is the rejection of usury, along with the requirement that there must be no engagement in immoral businesses.
  • Usury is seen as the levying of unreasonably high interest rates while lending money. Interest is Riba, which in its current interpretation, covers all interest — not just excessive interest.
  • Under Islamic law, a Muslim is prohibited from both paying and accepting interest.
  • Thus, Sharia banking means money can only be parked in a bank without interest — and this money cannot be used for speculative trading, gambling, or trading in prohibited commodities such as alcohol or pork.

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Then, how does a bank work without interest being charged or given?

While banking itself is premised on charging interest while lending and paying interest on deposits, certain banks do structure their accounts in Sharia compliant ways.

Ijara:

  • For those who want to take credit from a Sharia compliant bank the instrument of Ijara is available — in which the bank purchases the asset on behalf of the client and allows its usage for a fixed rental. After a mutually agreed time, the ownership of the asset is transferred to the client.

Murabaha

  • Another instrument is the Murabaha for working capital, in which the asset is purchased by the bank at market price and sold to the customer at a mutually-decided marked-up cost. The client can repay in instalments.

Musharaka

  • Musharaka is a joint investment by the bank and the client, in which both contribute to funding an investment or purchase, and agree to share the profit or loss in agreed-upon proportions.

Two kinds of deposits

For savings accounts, there are two kinds of deposits.

  1. In one, customers can deposit their savings and allow the bank to use this money, with the assurance that they would get the full amount back. The bank is not liable to pay interest to the savers. However, some banks do give a certain sum back to the account holder as profit accrued from their operations.
  2. In the other kind, the holder allows the bank to invest his money in specific projects and gets returns after a stipulated term based on how the business performs.

Is usury the same as the conventional banking systems?

  • Some religious scholars have noted that the interest in the conventional banking systems is not the same as usury, and the levying and receiving of interest at a fixed rate is allowed.
  • Large parts of the Islamic world, including Pakistan, adhere to conventional banking practices.

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What is the rationale for Sharia banking?

  • The concept is aimed primarily at devout Muslims who do not participate in the conventional banking system due to religious restrictions, including not taking credit from banks to expand businesses.
  • Introduction of Sharia or Islamic banking could bring more Muslims into the banking system, and help in the inflow of institutional wealth from entities operating in the Islamic world to the Indian economy.

Is Sharia banking restricted to Muslims alone?

  • Sharia banking is not restricted to Muslims alone, and other communities who are interested in other forms of banking like ethical banking could be allowed to participate.

Sharia banking globally:

  • A 2015 World Bank report estimated Sharia-compliant financial assets to be in the range of US $ 2 trillion, covering bank and non-bank financial institutions, capital markets, money markets and insurance.
  • The Islamic Finance Industry has been expanding at a rate of 10%-12% annually.
  • According to the World Bank, in many Muslim countries, Islamic banking assets have been growing faster than conventional banking assets.
  • There has also been a surge of interest in Islamic finance in non-Muslim countries such as the UK, Luxembourg, South Africa, and Hong Kong.

Introduction of Islamic Banking in India:

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  • In a report submitted to the government in 2008, a committee headed by Raghuram Rajan had, without naming Sharia banking, suggested the need to have interest-free banking in India.
  • The Kerala government had subsequently tried to co-promote an Islamic finance institution, but the move was challenged in the High Court.

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Strong case for Islamic Banking in India:

  • In his report on the Financial Sector (2008), Raghuram Rajan recommended that interest-free banking techniques should be operated on a larger scale so as to give access to those who are unable to access banking services, including those belong to economically disadvantaged section of the society.
  • There are many advantages in introducing an Islamic window in the banks. For instance, majority of companies in the Stock Exchange are shariat compliant (this number is more than the shariat complaint companies on the Stock Exchange in Malaysia), thus this would result in attracting huge funds in the domestic market alone.
  • An Islamic Banking window will encourage many from the Muslim community to come forward and invest in projects thereby mobilising huge amount of capital which they may not be willing to put in the banks. This also means that India will be able to attract huge investments from West Asia and from those who invest only in shariat compliant projects.

Difficulties in implementing Islamic Banking in India:

Islamic banking india2 iastoppers

  • Indian banks have no experience in the Islamic or Sharia banking. There are also lots of complexities of Islamic finance. There are also various regulatory and supervisory challenges involved in the matter.
  • Because of the strict adherence to not paying or taking interest, Sharia banking will call for a complete overhaul of the banking regulatory system.
  • There is also concern that India lacks adequate manpower trained in Sharia banking.

Way ahead:

  • The RBI has now said that given the complexities of Islamic finance and various regulatory and supervisory challenges involved, and also due to the fact that Indian banks have no experience in this field, Islamic banking may be introduced in a gradual manner.
[Ref: Indian Express, Scroll]

 

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