Islamic Banking in all over India
Islamic banking is a banking which follows the principles of islamic laws (Shariah) which prohibits interest based banking‘ and permits only profit sharing based banking‘. The concept is based on a verse of the Holy Quran that says “Allah has allowed only legitimate trade and prohibits interest”. It is against the interest, as interest is believed to lead to exploitation and unproductive income.
An Islamic Banking is a financial institution that operates with the objective to implement and materialise the economic and financial principles of Islam in the banking arena.
Islamic banking Definitions:
The Organisation of Islamic conference (OIC) defined an Islamic Bank as a financial institution whose statutes, rules and procedures expressly state its commitment to the principles of Islamic Shariah and to the banning of the receipt and payment of interest on any of its operations.
According to Islami Banking Act 1983 of Malaysia, an Islamic Bank is a company which carries on Islamic Banking business. Islamic Banking business means banking business whose aims and operations do not involve any element which is not approved by the religion Islam.
According to Investopedia, Islamic banking, also referred to as Islamic finance or shariah-compliant finance, refers to finance or banking activities that adhere to shariah (Islamic law). Two fundamental principles of Islamic banking are the sharing of profit and loss, and the prohibition of the collection and payment of interest by lenders and investors.
Investordictionary defines, Islamic banking refers to a system of banking which is consistent with Islamic law and guided by Islamic economics. In particular, Islamic law prohibits the collection of interest, also commonly called riba in Islamic discourse. One form of the argument against interest is that money is not a good and profit should be earned on goods and services only; not on control of money itself. (Return on Assets).
While Islamic law prohibits the collection of interest it does allow a seller to resell an item at a higher price than it was bought for, as long as there are clearly two transactions.
In wikipedia, Islamic banking or Islamic finance or sharia-compliant finance is banking or financing activity that complies with sharia and its practical application through the development of Islamic economics.
Managementstudyguide says, Islamic banking is the operation of banks which are consistent with the Sharia law. Since the Sharia law prohibits the collection of interest as well as any transactions which allow speculation, it is in conflict with the basic tenets of banking. Therefore the challenge in Islamic banking is to meet the financial needs of people while staying in line with the Sharia law.
Islamic banking is defined as banking system which is in consonance with the spirit, ethos and value system of Islam and governed by the principles laid down by Islamic Shariah. While
Islamic banking has a broader scope and meaning, it is generally referred to the transformation of conventional money lending system into Asset-backed financing transactions conducted by
the Financial Institutions.
What is meant by Shariah/Islamic Law?
Shariah lexically means a way or path. In Islam Shariah refers to the divine guidance and laws given by the Holy Quran, the Hadith (sayings) of the Prophet Muhammad (Sallalahu Alaihi
Wassalam) and supplemented by the juristic interpretations by Islamic scholars. Shariah embodies all aspects of the Islamic faith, including beliefs and practices. Islamic Shariah or the
divine law of Islam is derived from the following four sources:
1. The Holy Quran
2. The Sunnah of the Holy Prophet (Peace Be Upon Him)
3. Ijma’ (consensus of the Ummah)
4. Qiyas (Anology)
What is the philosophy of Islamic banking?
The philosophy of Islamic banking takes the lead from Islamic Shariah. According to Islamic Shariah, Transactions involving interest/riba, Gharar and Maiser are prohibited. Moreover, they
cannot deal in any transaction, the subject matter of which is invalid (haram in the eyes of Islam). Islamic banks focus on generating returns through investment tools which are also
Shariah compliant. Islamic Shariah links the gain on capital with its performance. Operating within the ambit of Shariah, the operations of Islamic banking are based on sharing the risk
which may arise through trading and investment activities using contracts of various Islamic modes of finance.
Basic Principles of Islamic Banking:
- Receipt and payment of interest (Riba) is strictly prohibited.
- The business is based on sharing profit and loss.
- Certain industries, such as adult entertainment, alcohol, and gambling are disallowed by Sharia and prohibited for investment. This is why Islamic Banking is also referred to as Ethical banking.
- Banks may not lease or lend any product that they do not wholly own.
- Trading in debt is also not allowed, which is why Banks do not deal in traditional bonds; rather they have their own version of such instruments called Sukuk (Islamic Bond).
- Interest free loans are encouraged to spread financial inclusion
The disclosures coming to light for prohibitions of interest by Islamic Laws are:
- The interest deprives someone from the blessings of ‘Allah’ as it leads to taking away of property actually belonging to someone;
- Muslims should stay away from interest for their own welfare as it eventually invites ‘Allah’ fury;
- The Law prevents taking of any type of agreed and prearranged amount over and above the actual principal amount from the borrower. And in case the borrower is unable to repay the
- principal then they should also forgo their demand for principal. The Islamic Law condemns not only those who demands interest but also those who pay interest.
All interest-free banks agree on the same basic principles. However, individual banks differ in their application. These differences can be because of several reasons including the laws of the country, objectives of the different banks, individual banks circumstances and experiences, the need to interact with other interest-based banks, etc.
CONCEPTS IN ISLAMIC BANKING:
Amongst the common Islamic concepts used in Islamic banking are:
- Profit sharing (Mudarabah): Islamic Banks offer savings and time deposits in the form of investment accounts under the system of mudarabah. The depositors of such accounts share profits and/or losses of the institutions under an agreed-upon formula. The depositors in mudarabah accounts are the suppliers of capital, rabb al-mal, who entrust their funds to the bank, mudarib, in the tradition of Western style investment banking, subject to dealings with only noninterest bearing instruments. The mudarib, acting as money manager or agent, invests the money and then distributes the profits and/or losses on the basis of the agreed-upon contract. The following conditions must be met:
- Profits to be shared must be proportional to the funds contributed to the mudarabah account and these cannot be in lump sums or in guaranteed amounts. The loss to the depositor (contributor of funds) cannot be more than the amount of deposit.
- Non-interest bearing demand deposits (checking accounts): Conventional checking accounts in modern commercial banks are non-interest bearing deposits, and since Islamic Banking Institutions shun interest rate based dealings, most of them offer such demand deposit accounts. Ideally, Islamic Banks should not be charging any fees on checking accounts as they are free to employ the depositors‘ money, subject to the reserve requirements, if there are any, into earning assets. In practice, however, this is not always the case. Depending on the size of the deposit, service charges and fees get collected to meet operating costs.
- Joint venture (Musharakah): The third instrument used by Islamic Banks is musharakah, which is a form of equity financing through joint ventures. Unlike the case of mudarabah, here the bank not only participates in the supply of capital to the venture, but also in its management. Thus, the Islamic Banking Institutions assumes the role of an entrepreneur as well as that of a financier
- Cost plus (Murabahah): The fourth instrument, murabahah (or more specifically, baimujal murabah -cost plus financing), used by the Islamic Banks consist of transactions where the institution buys a product (e.g., a car or a machinery) on a client‘s behalf and then resells this with a mark-up to a client, the borrower. Thus, an automobile selling at a price of $20,000 may be bought by the Islamic Banking Institutions and resold to a client at $25,000, to be paid back in monthly installments (or a lump sum at the end of the loan term) over a 2-year period. Instead of interest in a traditional loan, the bank makes a profit with the difference of the purchase value.
- Leasing (Ijarah): The fifth instrument used by the Islamic Banks is ijarah or leasing. Two types of leases are used. In one, the lessee pays the lessor installment payments that go towards ultimate purchase of the equipment by the lessee. This type of lease/purchase agreement is known as ijarah Wa-iqtina. The second type of lease maintains the ownership of the lessor as per the lease contract.
WHAT ARE THE IMPACTS OF ISLAMIC BANKING IN INDIA?
1) India is a secular country by constitution. Thus opening any financial institute with the name of religion can raise question among other religious groups.
2) There would much of chaos for manpower in Islamic banking. There is a lack of adequate work force trained in Shariah Banking.
3) The present banking rules and regulations in India do not allow the operation of islamic finance in India for it creates hurdle in achieving complete financial inclusion.
4) Section 8 of Banking regulation act, mandates that a banking company cannot deal in the selling and buying or bartering of goods, which is prevalent in Shariah-complaint structures such as Mudarabha in India.
5) Islamic banking may pave the way for the entry for terrorist funding.
Islamic Development Bank (IDB) in May 2016 announced to open its first branch in India at Ahmedabad, Gujarat. IDB is headquartered at Jeddah, Saudi Arabia. The plans to set up the branch at Gujarat is part of MoU signed between India’s EXIM Bank and IDB during Prime Minister Narendra Modi visit to United Arab Emirates (UAE) in April 2016.
Concept of Islamic Banking in India
A committee headed by Raghuram Rajan submitted a report to the government in 2008, in which the committee, without naming Sharia banking, suggested the need to have interest-free banking in India. The report said that the non-availability of interest-free banking products in India eventually results in some Indians, including those in the economically disadvantaged strata of society, not being in a position to reach the banking products and services due to reasons of faith. This non-availability also forbids access of many Indians to substantial sources of savings from other countries in the region. As a consequence, the Kerala government had tried to co-promote an Islamic finance institution, but this move was challenged in the High Court.
The concept of Islamic Bank got further push with the recommendation from the committee named as “Medium-Term Path for Financial Inclusion”, headed by Deepak Mohanty. This committee has advocated “interest-free windows” in existing conventional banks. On the other hand, the government also appears to be inclined towards implementing the Islamic banking.
The government has advised the RBI that before taking a decision about Islamic Window, the legal, regulatory, technical, issues need to be clarified by the RBI. After this, an inter-departmental group on Islamic /Alternative Banking was formed within the RBI to evaluate the issues for introducing Islamic banking.
The State Bank of India (SBI) had launched a Shariah-compliant mutual fund in 2014. It was the first time a state-owned bank rolled out an Islamic financial instrument for the country’s estimated 170-million Muslim populations.
Why Islamic Banking in India?
India has a substantial Muslim population, this not only showcases a huge potential for the growth of Islamic Finance but also an inherent necessity for it. In 2011, there were approximately 180 million Muslims living in India, and this is estimated to rise to 310 million by 2050. This will make India home to the largest Muslim population in the world. In India, at the same time, most Muslims are self-employed and most of their investments are not adequately supported by banks.
Presently, there is a need to increase financial inclusion of Muslims in India, which has not happenedsubstantially because the Indian Banking and Financial system has failed to take note of Islamic Financial principles. And as a result, it failed to develop financial products like the Middle East and Europe.
A report released by Sachar Committee back in 2006 points out the necessity of Islamic Finance in India. The report said Muslims hold 12 per cent of accounts in public sector banks and 11.3 per cent in private sector banks which are less than their share of 13.4 percent of the overall population. So the Muslim population is in need of financial Inclusion and Islamic banking is a prominent idea to satisfy this need.
Problems for Islamic Banking in India
India is a secular country by Constitution. So opening any financial institution with the name of a religion can raise questions among other religious groups. Apart from this, some political parties have said they will oppose the introduction of Islamic banking in India. Another reason that has withheld growth of Islamic Banking in India, is the lack of adequate work force trained in Sharia banking.
And Islamic banking is based on strict Sharia laws of not paying or taking the interest, so the application of Islamic banking will call for a complete change in the banking regulatory system.
The foremost concern for the development of Islamic banking in India is the development of comprehensive legislation, regulations and rules governing the same. Former RBI Governor D. Subbarao objected that present rules and regulations do not allow the operation of Islamic Finance in India, and this creates a major hurdle to achieving complete financial inclusion, given India’s growing and prominent Muslim population.
The banking in India is governed by the laws made in the archaic Negotiable Instruments Act of 1881, Reserve Bank of India Act, 1934, and Banking Regulation Act of 1949.
The core principles of all of these legislations stand in direct conflict with the principles of Islamic Finance. For example, the payment of interest on deposits is mandatory under the Section 21 of the Banking Regulation Act, but it is clearly prohibited under the Riba principle.
Section 8 of Banking Regulation Act, mandates that a banking company cannot deal in the selling or buying or bartering of goods. This shows the impossibility to have Shariah-compliant structures such as Murabaha in India.
One of the criticisms of the introduction of Islamic banking in India is Subramanian Swamy’s suspicion about it. He objected to the launch of Islamic Banking in India by saying Islamic banking will pave the way for the entry the dubious funds of the Middle East into India through legally baptized channels of Sharia compliant financial institutions. And he highlighted that these dubious funds hold the volatility to be used for terrorist funding. He also claimed that it can raise the rate of Islamic conversions in India.
SO, WHAT NOW?
The criticism that introducing Islamic banking in India will raise Islamic conversions in India is avoidable because in countries like Singapore and Malaysia there have not been any such incidences. And the scepticism that Islamic banking will enhance funding to the terrorist organizations seems flawed because all the money circulation in the Banking sector in India is under the regulation of the RBI. So, it is very unlikely that any RBI affiliated bank can send money to any banned terrorist organization.
Another doubt about Islamic banking which says it will harm the secular fabric of the country can be questioned. Because Islamic banking will serve the need of many people who have been marginalized and it will bring them into mainstream banking. So, it is an inclusive step and our secularism is meant to promote inclusive values. Thus it can be said it will not harm the social fabric of the India.
So, we have discussed the reasons which are in favour of Islamic Banking in India and also the reasons which are against it. By viewing both perspectives, it seems reasonable to say that a gradual introduction of Islamic Banking should be a welcome step in India. The Indian government also strongly emphasizes and supports the idea of finance inclusion. A noticeable part of Indian population still needs to be a part of Financial Inclusion program of the government. So initiatives about Islamic Banking should be taken in future.
BENEFITS THAT SHOWERED BY ISLAMIC BANKING
Islamic Banking when successfully introduced in India will provide lots of benefits to the
Muslim Community and the country at large namely;
- Inclusive Economic Growth: The advent of Islamic Banking in India will throw open fresh avenues of inclusive economic growth, not only for the Muslim community, but also other fellow countrymen through novel instruments of finance based on equity and not interest. This might also help improve the poor socio-economic status of the Muslim community as highlighted by the Sachar Committee and the glaring economic disparities, which is an indication of the lack of inclusive economic growth. This may also be attributable to the lack of participation by the community in the financial sector.
- Growth of FDI: The introduction of Islamic banking in India will offer Muslims a socioreligiously acceptable mode of finance and investment, motivating not only retail investors, but also beneficiaries of various Shariah-compliant schemes. Doors will be opened to foreign direct investment (FDI) and foreign institutional investment, particularly from renowned business houses of Gulf Cooperation Council countries.
- Availability of Funds for Business: While Shariah-compliant, equity-based microfinance organisations at the grassroots and apex levels will be able to provide much needed financial inputs by way of tools, equipment and machinery under the ijarah waiktina (lease-cum-purchase), the murabahah (cost-plus financing) instruments of Islamic finance can be used to provide funds for trading and raw material purchases for manufacturers.
- Free from Exploitation: Renowned scholar and senior adviser to the Islamic Research Institute of the Islamic Development Bank, Saudi Arabia, Dr Mohammad Umar Chapra has stressed the need for implementing Islamic Banking and economy system for setting up a true welfare state. Dr Chapra views that by adopting true Islamic system of economy and banking, a welfare society could be created where people were saved from exploitation and their basic needs were met
Islamic banking in India SWOT Analysis
The Indian banking sector has opened up considerably in the past decade or so and openness to interest-free banks is a logical next step. Islamic banking is one way to ameliorate the disadvantaged classes. The potential benefits of allowing Islamic banking include; decreased economic disparity between the haves and the have nots, better integration, and consequently accelerated economic growth. Government of India can leap a step closer towards the fulfillment of Indira Gandhi’s much cherished dream of “Garibi Hatao” by reforming its banking sector and allowing the establishment of Islamic Banks.
To get a clear picture, let us analyze the position of Islamic banking in India on SWOT (Strength, Weakness, Opportunity and Threat) Scale. SWOT analysis will help us to logically examine the chances if this concept would flourish or flounder in India.
Islamic Banking will unequivocally ameliorate the deplorable condition of the poor and marginalized segments of society. Banking products which comply with Islamic law are becoming increasingly popular, not only in the Gulf countries and far eastern states like Malaysia, but also in other developed markets such as the United Kingdom. Reputed banks like Standard Chartered, Citibank, HBSC are operating interest free windows in several West Asian countries, Europe and USA. There is a huge potential market in India for Islamic banking products.
We have seen the fall of giants in the world of financial sector like Lehman Brothers in the aftermath of the US sub-prime mortgage crisis. Therefore, it is of paramount importance to be strict about credit rating system, to circumvent any chance of further bankruptcy. Since Islamic banking adheres to strict credit rating system and prohibits indebted economic agents to avail more debt finance, it could save our financial and economic enterprises from bankruptcy. Interest is strictly proscribed in Islamic banking. Principles of equity finance abhor financing the indebted enterprises thereby arresting the chances of bankruptcy to great extends. Under Islamic banking, equity finance needs cost yield and pre-rating analysis of projects. It thus considerably subdues the mindless competition in financial sector to get more credit shares and tends to provide stability in the financial market. Islamic banks are unaffected by the subprime mortgage crisis. In fact, now many non-Muslim countries are turning up to Islamic banking as they are immune against such crisis due to inherent business ethics within Islamic banking.
Moreover, Islamic banking helps the weaker and hapless section of the society through various financial products. Islamic banking finances (through its Joint ventures,partnerships and leasing)are provided by investors or banks to the borrowers with a condition that financial risk is to be borne by the investors, and other risks to be borne by the borrower. This helps even the indigent and vulnerable to get finance at a no risk and cost basis, but definitely requires other credits like strong business proposal, rational planning, skilled hands and specialized art to attract the financier. Better business proposals succeed in fetching funds as opposed to the projects with comparatively poor propositions. Such inclusive growth will aggrandize the Indian economy.
A bank in India cannot raise deposits without promising a specified rate of return to depositors, but under Sharia, returns can only be determined post-facto depending on profit. Also banks have to maintain a Statutory Liquidity Ratio (SLR), which involves locking up a substantial portion of funds either as cash, gold or in government securities. Such cash will not get any return, keeping it in gold is risky as it could depreciate and government securities come with interest.Moreover, Islamic banking can eliminate unaccountable economic activities, as every economic activity has to be financed through legal contract and physical verification of real assets under contract. There is no room for diversion of funds. Therefore, investment in consonance with Islamic banking principles will surely boost the engine of economic growth in our country.
The high powered Raghuram Rajan Committee draft Report as released on 7th April 2008, strongly suggested interest-free banking as a part of recommendations made for financial sector reforms. The Committee postulates that interest free banking is another area that falls broadly in the ambit of financial infrastructure.Certain faiths prohibit the use of financial instruments that pay interest. The non-availability of interest-free banking products (where the return to the investor is tied to the bearing of risk, in accordance with the principles of that faith) results in some Indians, including those in the economically disadvantaged strata of society, not being able to access banking products and services due to reasons of faith. This non-availability also denies India access to substantial sources of savings from other countries in the region. While interest-free banking is provided in a limited manner through NBFCs and cooperatives, the Committee recommends that measures be taken to permit the delivery of interest-free finance on a larger scale, including through the banking system. This is in consonance with the objectives of inclusion and growth through innovation. The Committee believes that it would be possible, through appropriate measures, to create a framework for such products without any adverse systemic risk impact.
Indian banking laws do not explicitly prohibit Islamic banking but there are provisions that make Islamic banking almost an unviable option. The financial institutions in India comprises of Banks and Non Banking Financial Institutions. Banks in India are governed through Banking Regulation Act 1949, Reserve Bank of India Act 1934, Negotiable Instruments Act 1881, and Co-operative Societies Act 1961.
Certain provisions regarding this are mentioned below:
Section 5 (b) and 5 (c) of the Banking Regulation Act, 1949 prohibit the banks to invest on Profit Loss Sharing basis -the very basis of Islamic banking.
Section 8 of the Banking Regulations Act (BR Act, 1949) reads, “No banking company shall directly or indirectly deal in buying or selling or bartering of goods…”
Section 9 of the Banking Regulations Act prohibits bank to use any sort of immovable property apart from private use –this is against Ijarah for home finance
Section 21 of the Banking Regulations Act requires payment of Interest which is against Sharia.
As regards to partnership by Islamic banks in a firm, the bank has to make sure that the manager does not avoid his responsibilities or obtain other non-pecuniary benefits at the expense of non-participating partners and ensure the veracity of the profit statements. Monitoring of data about firms in which Islamic bank invests would involve exorbitant cost. However, Islamic banks need to set up monitoring cell to keep them informed of the internal function of their joint venture. The implication is that banks and entrepreneur have to function very closely.
Islamic banking needs to introduce corporate governance with transparent accounting standards. It needs to perform detailed evaluation before embarking Profit Loss Sharing Scheme, which demand a pool of highly trained professionals. The imparting of professional training is costly. Detailed principles are still to be laid down and techniques and procedures evolved to carry them out. It is only after the satisfactory achievement of these that proper training can begin.
It is observed that inability to evaluate a projects’ profitability has tended to act against investment financing. Some borrowers frustrate the banks appraisal efforts as they are reluctant to provide full disclosures of their business. These exercises are not limited to relatively few large loans but need to be carried out on nearly all the advances made by the bank. Yet, widely acceptable and reliable techniques are yet to be devised.Moreover, the borrowers do not observe business ethics which make it difficult to establish close bank-clientele relationship – a condition for successful Islamic banking. Adverse selection has been one of the major impediments in the world of Islamic banking.
Among the other disincentives from the borrower’s point of view are the need to disclose his accounts to the bank if he were to borrow on the Profit Loss Sharing basis. However, many small-time businessmen do not keep any accounts, leave alone proper accounts. And large conglomerates do not like to disclose their real accounts to anybody. The widespread lack of business ethics among certain business community will be another major hurdle in the path of Islamic banking in India.
The practices in use by the Islamic banks have evoked questions of morality. Some critics view Sukuk(Islamic Bond) as unIslamic in nature. Others criticize that financing through the purchase of client’s property with a buy-back agreement and sale of goods to clients on a mark-up, involved the least risk and are closest to the old interest-based operations. Bai’ mu’ajjal (sale with deferred payment) and Murabaha (cost-plus financing) are permitted in the Sharia under certain conditions.What is being done in many countries are fictitious deals which ensure a predetermined profit to the bank without actually dealing in goods or sharing any real risk. This is against the letter and spirit of Sharia.
India with a 15% Muslim population, the highest in a non-Islamic country and second highest in the world offers huge opportunities to exploit . The size of the market will be very large as the Indian population is above 100 crore and Muslim population itself is about 15 crore and majority of them, in the name of religious faith, are looking for interest free banking and finance. It is pertinent to mention here that Islamic banking is not meant for Muslims only but non Muslims may also avail the benefit of it. And it is feasible to have a parallel banking system based on Sharia along with a conventional one.
After 9/11, most of these countries started pulling out their investments from the US and Europe because of the fear of freezing of assets. Another reason could be the slowdown in the economies of western countries. A growing Indian economy has created a huge enthusiasm among Islamic nations as it sees the unlimited opportunities it can avail. In fact, five Indian companies, Reliance Industries, Infosys Technologies, Wipro, Tata Motors and Satyam Computer Services figure in the Standard & Poor’s BRIC Sharia Index.
Eleventh Five Year Plan envisages inclusive growth with development in all sectors of economy. Islamic banking is an effective mechanism to subjugate the liquidity and inflation problems along with allowing inclusive growth. For real inclusive growth, we have to ensure increase in income and employment status of workers in all segments.
If Islamic banking is introduced, the inadequate labor capital ratio, for informal sector workers associated with agriculture and manufacturing industries could be resolved through equity finance, which might be a revolution in our agriculture and unorganized sector. With improved labor capital ratio, our vulnerable workers associated with agriculture and unorganized sector might be able to compete effectively with the formal sector workers. Thus Islamic Banking may financially empower majority of Indian workers.
Islamic banking may induce our political leaders to substitute grants and subsidies with equity finance schemes through specialized financial institutions because equity finance allows access to credit without debts of borrowers. Equity Finance helps achieve self-reliability which never comes through grant and subsidies. Islamic banking should not be a religion based banking business, but could be profitably used to resolve our issues pertaining to economy.
Moreover with introduction of Islamic banking, Indian government will certainly gain diplomatic advantages to make financial dealings with Muslim dominated nations especially to attract trillion dollars of equity finance from the gulf countries. This is more important after the fall of the titans like Lehman Brothers because it reflects the economic downturn in the west and the need of alternative sources of FDI for the Indian economy. India needs to provide a congenial economic environment to attract the financial inducement from the Gulf region.
Islamic scholars have defined market instruments in length and they have permitted with some conditions to have investments in stock market .Certain broad criteria are:
The company’s activities should not include liquor, pork, hotel, casino, gambling, cinema, music, interest bearing financial institutions, conventional insurance companies, etc.
The total interest bearing debt of the company at any point in time should remain below one third of its average market capitalization during the last twelve months.
Its aggregate of account receivables should remain below 45% of total assets.
If company has any interest bearing income it should not be more than 10% in any condition.
Islamic banking could be a huge political issue. Certain parties might abhor the use of the word “Islamic” and could term it as anti-Indian. They might argue that the very concept of Sharia banking would go against the secular fabric of our country. We are already facing problems pertaining to Muslim Personnel Law and trying to implement Uniform Civil Code. Therefore, at this juncture, if we introduce Islamic banking in India, it will create more problems than solving the issue. Moreover, it may bring financial segregation in the economy. The compartmentalization of Sharia compliant and Non Sharia Compliant banking might be used by certain vested interest to communalize the finance sector in India. Such questionably sane but unquestionably dangerous trend must be prevented with full might.
Difference between Conventional Banking Islamic Banking:
|Conventional Banking||Islamic Banking|
|1 . The functions and operating modes are based on fully man made principles||1. The functions and operating modes are based on the principles of Islamic Shariah.|
|2. It aims at maximizing profit without any restriction.||2. It also aims at maximizing profit but subject to Shariah restrictions|
|3. It can charge additional money (penalty and compound interest) in case of defaulters.||3. This type of banking has no provision to charge any extra money from the defaulters. Only small amount of compensation is charged and these proceeds are given to charity|
|4. Lending money and getting it back with compound interest is the fundamental function of the conventional bank.||4. Participation in partnership business is the fundamental function of the Islamic banks.|
|5. The investor is assured of a predetermined rate of interest.||5. It promotes risk sharing between provider of capital (investor) and the user of funds (entrepreneur).|
|6. Since income from the advances is fixed, it gives little importance to developing expertise in project appraisal and evaluations.||6. Since it shares profit and loss, the Islamic banks pays greater attention to developing project appraisal and evaluations|
|7. The status of a conventional bank, in relation to its clients is that of creditor and debtors.||7. The status of Islamic Bank in relation to its clients is that of partners, investors and trader, buyer and seller.|
|8. Conventional banking practices are concerned with elimination of risk when involve in any transaction.||8. Islamic banking practices are concerned with risk bearing when involved in any transaction.|
|9. It does not deal with Zakat (Islamic Tax)||9. In the modern Islamic Banking system, it has become one of the service-oriented functions of the Islamic Banks to be a Zakat Collection Centre and they also pay out their Zakat|
|10. When conventional banks involve in transaction with consumer they do not take the liability only get the benefit from consumer in form of interest.||10. Islamic banks bear all liability when involve in transaction with consumer. Getting out any benefit without bearing its liability is declared Haram in Islam|
Islamic Banking Investment Modes:
Investment is the action of Deploying Funds with the intention and expectation that they will earn a positive return for the owner. Funds may be invested in either real assets or financial assets. When resources are spent to purchase fixed and real assets. For example, the establishment of a factory or the purchase of raw materials and machinery for production purposes. On the other hand, the purchase of a legal right to receive income in the form of capital gains or dividends would be indicative of financial investment. Specific example of financial investment are, deposits of money in a bank account, the purchase of Mudaraba bonds.
There are different modes of investment under the Islamic Shari’ah which can be classified into three categories:
- Trading or Bai mode (Bai-Muazzal, Bai-Murabaha, Bai-Salam, Istisna’a)
- Partnership or Share mode (Mudaraba, Musharaka)
- Leasing/Izara mode (Hire purchase, Izara-Bil-Baia, Leasing)
Bai Murabaha mode of investment:
The term “Bai-Murabaha” have been derive from Arabic words ‘Bai’ and ‘Ribhun’. The word ‘Bai’ means purchase and sale and the word ‘ribhun’ means an agreed upon profit. ‘Bai-Murabaha’ means sale on agreed upon profit.
Bai-Murabaha may be define as a contract between a Buyer and Seller Under which the seller sells certain specific goods permissible under Islamic shariah and the Law of land to the Buyer at a cost plus agreed profit payable in cash or on any fixed future date in limp sum or by installments.
Important Features of Bai-Murabaha:
- To offer an order by the client to the bank.
- To make the promise binding upon the client to prophase from the bank and also to indemnity the damages caused by breaking the promise.
- To take security in the form of cash/kind/collaterals.
- To document the debts resulting from Bai-Murabaha.
- Stock and availability of goods is a basic conditi9on.
- Bank must bear the risk until delivery of goods to the client.
- Bank may sell it at a higher price.
- Price once fixed cannot be changed.
Bai-Muajjal mode of investment: the term ‘Bai’ and the ‘Muajjal’ have been derive from Arabic words ‘Bai’ and ‘Ajalu’. The word ‘Bai’ means purchase and sale and the word ‘Ajalu’ means a fixed time or fixed period. ‘Bai-muajjal’ means sale for which payment is made at a future fixed date or within a fixed period. In short, it is a sale on credit.
Bai Muajjal may be defined as a contract between a buyer and a seller under which the seller sells certain goods permissible under Islamic Sharia and the Law of the country to the buyer at an agreed fixed price payable at a certain fixed future date in lump sum or within a fixed period by fixed installment. The seller may also sell goods purchase by himas per order and specification of the buyer.
Important Features of Bai-Muajjal:
- It is permissible for the client to offer an order to purchase by the Bank particula goods deciding its specification and committing himself to buy the same from the bank on Bai-muajjal i.e. deffered payment sale at fixed price.
- It is permissible to make the promise binding upon the client to purchase from the Bank, that is, he is either satisfy the promise or to identify the damages caused by breaking the promise without excuse.
- It is permissible to take cash/collateral security to Guarantee the implementation of the promise or to identify the damages.
- It is also permissible to document the debt resulting from Bai-Muajjal bu a Guarantor, or a mortgage.
- Stocks and availability of goods is a basic condition for signing a Bai-Muajjal Agreement. Therefore, the Bank must purchase the goods as per specification of the Client of goods to acquire ownership of the same before signing the Bai-Muajjal Agreement with the client.
- After purchase of goods the Bank bust bear the risk of goods until those are actually delivered to the Client.
- The Bank must deliver the specified goods to the Client on specific date and at specific place of delivery as per Contract.
- The Bank may sell the goods at a higher price than the purchase price to earn profit.
- The price once fixed as per agreement and deferred cannot be further increased.
- The Bank may sell the goods at one agreed price which will include both the cost price and the profit. Unlike Bai-Murabaha, the Bank may not disclose the cost price and the profit mark-up separately to the Client.
Diference between Murabaha and Bai-Muazzal:
|1. Bank sell it at a higher price an spot payment or as any future date.||1. Bank sell it at a higher price but payment will be deffered.|
|2. Bank must bear the risk until delivery of goods to the client.||2. Client bear the risk of goods as the Possession of goods are in party control.|
|3. Possession of goods under bank’s control.||3. Possession of goods under party’s control.|
|4. Cost of the goods sold and the amount of profit should be mentioned in the Murabha Agreement.||4In Bai-Muazzal mode any selling price of goods should be mentioned in the Bai-Muazzal agreement i,e.|
|5. Pledge of goods by the bank.||5. Goods to be hypothecated by the bank.|
Definition of Mudaraba:
Mudaraba is a partnership in profit whereby one party provides capital and the other party provides skill and labour. The provider of capital is called “Shahib al-maal” while the provider of skill and labour is called “Mudarib”.
Types of Mudaraba:
Mudaraba Contracts are generally divided as under:
- Unrestricted Mudaraba and
- Restricted Mudaraba
Unrestricted Mudaraba may be defined as a contract in which the Shahib al-maal permits the Mudarib to administer the Mudaraba fund without any restriction.
Restricted Mudaraba may be defined as a contract in which the Shahib al-maal restricts the actions of the Mudarib to a specified period or to a particular location or to a particular type of business.
Terms and elements of Mudaraba:
* Contracting Parties
There are two contracting parties in Mudaraba:
- The provider of the capital i.e. ‘Shahib al-maal’ and
- The Mudarib.
Capital is the amount of money given by the provider of funds i.e. Shahib al-maal to the Mudarib with the purpose of investing it in the Mudaraba business.
* Profit & Loss:
Profit should be for both Shahib al-maal and Mudarib as per agreed ratio. Loss should be borne by the Shahib al-maal.
The main features of Mudaraba:
- a) There should be two parties: Shahib al-maal (financer/Investor) and businessman is Mudarib (Who provides skill and labour).
- b) There should be written agreement/contract between the Bank and the businessman which includes nature of business, period/time, sharing of profit etc.
- c) Bank will finance and the businessman will run the business by providing his labour & skill.
- d) The Bank will not interfere in the business.
- e) The businessman will appoint employee(s) and he will run the business independently.
- f) The Shahib al-maal /Financier/Investor reserves the right to check/verify the accounts of the business at any time.
Definition of Musharaka:
Musharaka is a contract of partnership between two or more parties in which all the partners contribute capital, participate in the management, share the profit in proportion to their capital or as per pre-agreed ratio and bear the loss, if any, in proportion to their capital/equity ratio.
Types of Musharaka:
In the context of Islamic Banking financing, Musharaka may be of two types:
- Permanent Musharaka
- Diminishing Musharaka
Permanent Musharaka may be defined as contract of partnership business between the Islamic Bank and its clients in which the Bank participates in the equity and share the profit at a pre-agreed ratio or bear the loss, if any, in proportion to the ratio of capital/equity where termination period of the contract is not specified. This is also called continued Musharaka.
Diminishing Musharaka is a special form of partnership in which one of the partners promises to buy the share of the other partner gradually until the title to the equity is completely transferred to him.
There are two or more contracting parties known as partners. It is a condition that all the partners should be competent to give or be given power of attorney.
Capital contributed by the partners may be in the equal or unequal and in the form of cash or cash equivalent, goods & commodities, assets or properties etc.
Distribution of Profit:
Profit should be distributed among the partners as per their ratio of capital or as per agreement.
Distribution of Loss:
The loss, if incurred in the business, shall be borne by the partners exactly according to the ratio of their respective capital.
Some Important Features of Musharaka:
- Capital should be specific
- Equal share is not a must
- Nature of capital may be money or valuables
- Active participation of partners
- Ratio of profit prefixed
- Variation in share of profit permissible
- Participation and sharing profit & loss
- Partners retains the ownership and right to management
Difference between Mudaraba and Musharaka:
|1. The capital in mudaraba is the sole responsibility of Shahib al-maal.||1. In Musharaka it comes from all the partners.|
|2. In Mudaraba, the Shaheb al-maal has no right to participate in the managemant which is carried out by the Mudarib only.||2. In Musharaka, all the partners can participate in the management of the business and can work for it.|
|In Mudaraba the loss, if any is suffered by the Shahib al-maal only, because the Mudarib does not invest anything. His loss is his labour and skill.||3. In Musharaka, all the partners share the loss to the extent of the ratio of their investment.|
Bai-Salam is a combination of two Arabic words Bai and Salam. Bai refers to Purchase and Sale while Salam means Advance. Payment of Bai-Salam transaction is made in advance. It is a form of sale on delayed terms in which the money may be paid first and the goods delivered at a later date.
Bai-Salam is sale whereby the seller undertakes to supply some specific goods to the buyer at a future date in exchange for an advanced price fully paid on the spot.
Bai-Salam may be defined as a contract between a Buyer and a Seller under which the Seller sells in advance the certain goods permissible under Islamic Shari’ah and the law of the land to the Buyer at an agreed price payable on execution of the said contract and the goods is/are delivered as per specification, size, quality at a future time in a particular place.
The components of Bai-Salam:
The components of Bai-Salam contract are:
The contract parties i.e. Seller and Buyer
The price and the merchandise
The specifications of the contract.
Important features of Bai-Salam:
- a) A commodity /product sold without having the same in existence or possession of the seller. Commodity ready for sale, Bai-Salam is not allowed in Shariah.
- b) Generally to meet instant need of the seller so that production is not hampered due to shortage of fund/cash and as such. Industrial and agricultural products are purchased/sold in advance under Bai-salam.
- c) Permissible to obtain collateral security from the seller to secure the investment from any hazards (non supply, partial supply, low quality).
- d) Permissible to obtain mortgage / or personal guarantee from a third party before or at the time of signing the agreement.
- e) Bai-Salam on a particular commodity/product or on a product of a particular field or farm cannot be effected (Agri. Product only).
- f) Bai-Salam is not permissible for any ready goods/products.
- g) Unit price and total price of the goods must be fixed and mentioned in the contract.
- h) The exact time and place of delivery must be specified.
The word Istisna’a has been derived from a Arabic word which means Industry. Istisna’a means to purchase specific product(s) by placing order to a manufacturer or to sale specific product(s) after having the same manufactured against order of a buyer.
Istisna’a is a contract between a manufacturer/seller and a buyer under which the manufacturer/seller sells specific product(s) after having manufactured, permissible under Islamic Shari’ah and Law of the Country after having manufactured at an agreed price payable in advance or by instalments within a fixed period or on/within a fixed future date on the basis of the order placed by the buyer.
In short, it is a contract with a manufacturer to make something.
Features of Bai-Istisna’a:
- a) Istisna’a contract is another exceptional method where by commodities are bought and sold without existence of it.
- b) Delivery of goods is deferred and payment may also be delayed. Advance payment/ spot payment like Bai-Salam is not necessary. However payment may be made in advance or by installments.
- c) Sometimes advance payment against the goods is being paid to meet the production cost.
- d) Buyer gets the opportunity to make payment within the stipulated date in future or by installments.
- e) If the production of the commodity started or part payment is made, none of them can revoke the contract.
- f) If the product(s) are ready for sale, Istisna’a is not allowed in Shari’ah.
- g) It gives the buyer opportunity to pay the price in some future dates or by installments.
- h) Istisna’a is specially practised in Manufacturing and Industrial sectors. However, it can be practised in agricultural and constructions sectors also.
Diference between Istisna’a and Bai-Salam:
|1. The subject of istisna’a is always a thing which needs manufacturing.||1. Bai-Salam can be effected on anything, no matter whether it needs manufaturing or not.|
|2. It is not necessary in Istisna’a that the price is paid in full in advance.||2. It is necessary in Bai-Salam that the price is paid in full in advance.|
|3. The contract of Istisna’a can be cancelled before the manufacturer starts the work.||3. The contract of Bai-Salam, once effected, can not be cancelled unilaterally.|
|4. It is not necessary in Istisna’a that the time of delivery is fixed.||4. The time of delivery is an essential part of the sale in Bai-Salam.|
Takaful is commonly referred to as Islamic Insurance. It is based on the principle of cooperation and separation between operations of shareholders and the funds. The ownership of takaful fund and operations are passed to the policyholders. The policyholders are joint investors with the takaful operator who acts as a manager for policyholders. All policy holders agree to guarantee each other and contribute to a pool of funds (takaful fund) instead of paying premiums. Any claims made would be met out of the fund and surpluses will be distributed among policyholders. Takaful operator would be paid a fee only for managing the fund and covering the costs.
6) Qard Hasan:
Islamic banks lend loans keeping goodwill as the base. These loans are not charged with profit or interest. The borrower is required to pay only the amount borrowed. These loans do not charge the borrower the time value for the money. These loans are consistent with the principle of prohibition of interest.
7) HALAL ACTIVITIES:
Investing in any sinful (haram) activities are prohibited by Islamic Banks. . According to Shariah Law, it prohibits business projects related to gambling, pork products, weapons, defense, alcohol, pornography and any speculative activates.
An Islamic equivalent bond is termed as Sukuk. The investor of sukuk not only gets share of an asset but also the cash flows and the risk. As interest bearing bond structure is not permissible, the investor shall get a proportionate ownership in tangible asset of the project.
It is the acceptance of the sum of money for safe keeping. The sum of money accepted will be repaid. Here banker is the keeper and trustee of funds. Bank is liable for safekeeping of funds and on the demand of the customer it should be returned. As an appreciation for keeping the funds with the banks, banker as its discretion shall reward the customer as an appreciation (hibah).
It is equivalent to a forward sale contract in which the payment is made in advance and the goods are delivered at a specified date in the future. This mode often used in the agricultural sector in which without charging interest, the banks advances the money for in puts and in return shall get a part of produce which will be sold after its delivery.
It refers to a voluntary dedication of one’s property and wealth. This voluntary dedication should be exclusively for religious purposes. The waqf property can neither be sold nor inherited or donated to anyone. It should be used for Shariah compliant projects only.
Loan in Arabic is termed as Quard. Loan or Quard may be defined as follows:
To give any person a Fungible goods for using the same for his benefit on condition that he shall return similar goods in same quantity/amount within a fixed period or when possible for him. An analysis of this definition gives the following essential elements of loan:
- i) The goods must be Fungible one;
- ii) It must be given to someone for his use and benefit;
iii) There must be a condition to return similar goods in same quantity/amount;
- iv) There must have a period of maturity which may be fixed or may also be kept open;
- v) The lender does not bear any risk of the loan he lent;
- vi) Nothing additional (of the same goods or any other goods, services or benefit) over and above the principal should be imposed, charged or even expected against loan.
Any transaction having fulfilled these conditions, shall be termed a loan or Quard. This actually is what we call Quard-e-Hasansh.
Riba based Loan or Quard-ur-Riba
When any loan/Quard is offered or received on condition that certain additional amount or any other excess or benefit will be charged or be paid (over and above the principal) the loan or quard is turned into a Loan on Riba or Quard-ur-Riba, the excess being the Riba or interest.
Thus, the difference between Quard-e-Hasanah and Quard-ur-riba is that, in Quard-e-Hasanah, there is no excess but in Quard-ur-Riba there is excess which is Riba or interest. This excess is paid by the borrower to the lender for which borrower loses to that extents while the lender becomes gainer to the same extent. It is, thus, taking the excess paying nothing in return. This is great injustice. That is why it is Haram.
In Arabic it is termed as ‘Ajr’ which means consideration, exchange value, reward, wages, etc. It is the price of service of non-fungible goods.
The term ‘Ijarah’ has been derived from ‘Ajr’. Ijarah is one kind of Bai/Buying and selling. It is a mechanism by which the service of a non-fungible goods is sold in exchange of Rent (Ajr) keeping the goods and its ownership unsold. Thus it is an exchange of counter value, one side being the service and the other side the ‘Rent’. Therefore, it is Halal.
Definition (In general):
The fee charged by or paid to a broker, agent, or auto sales representative for negotiating a real estate, car sale, or loan transaction.
Definition (In the view point of Banking):
A fee paid to the Bank by a client for transacting a piece of business like negotiating sale or performing a service.
A commission is generally a percentage of the sales price/contract basis/fixed basis.
In view point of Shariah:
A fee charged by a broker or agent for his/her service in facilitating a transaction by rendering services. The payment of commission as remuneration for services rendered or halal products sold is a common way to reward sales people.
Difference between Quard, Riba, Profit and Rent
|1.||One good-Fungible||One good-Fungible||Two goods-Fungible||Two goods/ service-Non-Fungible|
|2.||No transformation.||No transformation.||Transformation.||Transformation.|
|3.||No risk of transformation and ownership.||No risk of transformation and ownership.||Risk borne.||Risk borne.|
|4.||Certain.||Certain.||Uncertain.||Fixed & certain.|
|5.||Condition to return similar goods in same quantity/amount.||Condition to return that certain additional amount or any other excess or benefit will be charged or be paid.||Condition to return not similar goods.||Condition to return not similar goods/service.|
|6.||It’s Halal.||It’s Haram.||It’s Halal.||It’s Halal.|
|7.||Buying and selling not required.||Buying and selling not required.||Buying and selling is must.||It’s one kind of buying and selling. It’s a mechanism by which the service of non-Fungible goods is sold in exchange of Rent.|