Islamic Banking

IN PARTIAL FULFILMENT OF THE REQUIREMENTS FOR MASTER OF FINANCIAL MANAGEMENT

2013-14

ROLL NO. 110

JAMNALAL BAJAJ INSTITUTE OF MANAGEMENT STUDIES, MUMBAI UNIVERSITY OF MUMBAI

Acknowledgement

I would like to thank Mr ________________ the of Dubai Islamic bank who helped me in understanding the dynamics of Islamic Banking, the interviewees who shared their valuable inputs on Islamic Banking, my husband who encouraged me to keep up the interest & clear focus, my friends for sharing the meaningful debates on the topic, my guide for helping me in streamlining the project work and last but not the least my Institute for giving me this wonderful opportunity to work on such an interesting topic.

Contents

Executive Summary For the last couple of years the growth of Islamic banking has outstripped the growth of normal banking. Currently there are 300 Islamic banks throughout the world holding assets over $270 billion. The Middle East, the South East Asia and South Asia are the main emerging hubs of Islamic banking and finance. This project outlines the functioning of Islamic banks globally and in developing countries, reasons why Islamic banking should be started in India, working of some of the Islamic financial organizations in India, what are the changes in regulation that are required and obstacles of Islamic banking in India. Finally conclusion has been provided whether Islamic banking is worthwhile to be persuaded in India or not. The project also includes opinions and interviews of Islamic Scholars providing their views on Islamic banking in India and how will it affect the country as a whole.

Chapter 1

Introduction to Islamic banking The term Islamic banking is striking and at the same time misleading. Often it is misunderstood as a bank catering to the needs of Muslim society. In reality, Islamic banking is for all irrespective of any religion, caste or creed. It is based on Islamic law (Shariah) and follows the Shariah, called fiqh muamalat (Islamic rules on transactions). Islamic banking, enlightened with the guidance of Islamic Sharia principles, is an alternative financial system that neither gives nor takes interest (riba), thereby having a fair system of social justice and equality, while fulfilling the financial needs of people and maintaining high standards of ethics and transparency. Islamic banking has emerged as a banking system in which millions around the world, irrespective of religious beliefs, are putting their faith in. Rather than opting for interest as a way of generating wealth, Islamic banking is unique way that helps individuals as well as businesses build tangible and appreciating assets for themselves. This not only leads to prosperity but also encourages the spirit of entrepreneurship amongst its customers. Islamic banks are based on the concept of profit and loss sharing with the customers by way of various Sharia-compliant financing and investment tools. Islamic banks provide an opportunity to the individuals and the businesses to build various assets which contribute to the development of the economy. Apart from this, the Islamic banks encourage the investment process through adopting innovative Sharia structures in all spheres of the economy, except in a few activities which are considered unethical such as gambling, alcohol and lottery.Due to their very nature of complying with the

Sharia principles, the Islamic banks are forbidden from indulging in any such practice, which may prove harmful to a customer. Islamic banking is also the first where a customer, whether individual or corporate, isn't just a customer, but is a partner with the bank or owner of goods or assets. This means they share the risks, as well as the profits of such a partnership or ownership. And this unique arrangement is done in accordance with the laws of Sharia, which ensures complete transparency at all times. Islamic banking therefore offers a portfolio of innovative, Sharia-compliant financial models that formalize this unique arrangement between customers and the bank. These are Murabaha, Musharaka, Mudaraba, Istisna, Salam and Ijara, to name a few. Another unique aspect of Islamic banking is the special status it accords to female customers. It was the first banking system to provide women with separate and specialized banking facilities for them to conduct their financial transactions in utmost privacy and comfort. And last but not least, Islamic banking is perhaps the only financial system to forbid the use of its finances or services for misleading, dishonorable, immoral and other purposes that would be harmful to society.

Evolution of Islamic Banking

The term Islamic banking became common in the 1960's, but the mechanisms and concepts of the system were implied and used since the birth of Islam. Charging interest on loans was not common back then.

The first time interest bearing loans were widely used in the Muslim world, especially in the Middle East, during the Ottoman Empire's rule in the 15th century. Mehmet Ebusuud Efendi, the senior Islamic cleric of the Ottoman Empire, issued a fatwa (ruling) allowing the charging of interest and considering it halal (permissible) as long as it was below 10%. Even though it was clear in The Holy Quran that interest was strictly prohibited, almost no one could challenge the senior Islamic clerics ruling because challenging him would mean challenging the Ottoman Empire's rule. Bankers back then were mostly Jews and Christians; many of them were Greeks and Armenians

After the Ottoman Empire's decline in the 1920's following World War I, the Middle East was divided by the major colonial powers. The British and the French had an agreement to split up the countries in the Middle East among themselves, while Italy took some parts of North Africa. The development of a modern banking system in Islamic countries occurred when their colonizers needed banks to fund different activities including agriculture, manufacturing and mining. After getting their independence following World War II, many Islamic countries nationalized their banks and established development banks to help governments fund the public sector and expand different industries. Back then, banks in Muslim countries were not addressing the need of devout Muslim customers, who held on to their money and avoided putting it in banks because of their interest-based system, which contradicts with their religious beliefs and principles. This led to the under banking of a big and important segment of the population whose savings were not used efficiently. This mismatch between the banks' operations and the devout Muslims' concerns lead some shariah scholars and bankers to work together and try to establish a new banking system which was more efficient. A system that can take advantage of devout Muslims' savings by pumping their money into the banking sector, while at the same time not jeopardizing their religious beliefs. That led to the establishment of the first Islamic bank in 1963; The Mit Ghamr Local Savings Bank in Egypt. The bank couldn't survive and had to close its doors 2 years later for different reasons including the lack of resources and support, but has paved the way for modern Islamic banking. Mit Ghamr Bank helped set general guidelines and came up with new terminologies that helped future Islamic banks and gave them the hope that Islamic banking can be competitive and profitable.

Since then, Islamic banking assets with commercial banks globally grew to $1.3 trillion in 2011, suggesting an average annual growth of 19% over past four years (2011: 24%). The top four markets account for 84% of industry assets. The Islamic banking growth story continues to be positive, growing 50% faster than the overall banking sector. Islamic banking assets are forecast to grow beyond the milestone of $2 trillion by 2014. Islamic banks continue to grapple with multiple challenges relating to sub-scale operation, asset quality, and negative operating income from core activities and a weak risk culture. Islamic banking the scenario worldwide Islamic finance has grown at a pace of 15 to 20 percent annually for the last five years and banking has been an important part in that. There are approximately 300 Islamic banks throughout the world with an estimated asset of $270 billion. According to experts, in the face of Globalisation, Islamic banks rank among top three in their markets. The largest markets for Islamic finance are Saudi Arabia, USA, Turkey this is considering Muslim population and per capita income. The fastest growing markets are Bahrain, Malaysia, and Indonesia. The potential for growth of Islamic finance is tremendous with estimates suggesting that within eight to ten years, half of saving of worlds 1.5 billion Muslims will be in Islamic banks. This means $905 billion assets in Middle East alone. When considered Muslims living outside Middle East, like in India, Indonesia, the assets base can grow significantly. International banks like HSBC, BNP

Paribas have branches in Arab region. Many other institutions are doing the same but have separate Islamic branches. The Middle East and Asia are two main markets where Islamic banks have flourished. Bahrain, Kuwait, Qatar, Saudi Arabia and the United Arab Emirates are active players in the Middle East. Egypt, Lebanon, Oman and the Syrian Arab Republic are catching up. In Asia, Malaysia has a fully developed Islamic financial system (consisting of banking, Takaful, or insurance, capital market and money market components). Other developing players include Brunei Darussalam, Indonesia, Pakistan, the Philippines and Thailand. The growth in these markets is fuelled in part by natural demand from the Muslim population within those countries. As awareness increases and Islamic banks extend their service, even non-Muslim customers have opted for Islamic banking facilities. This is normal in Malaysia, for example, where sometimes half of an Islamic banks customer base is non-Muslim. In the West, banks are also competing for a piece of the lucrative Islamic banking business pie.

Shariah-compliant Islamic models Wadiah (Safekeeping) Wadiah means custody or safekeeping. In a Wadiah arrangement, you will deposit cash or other assets in a bank for safekeeping. The bank guarantees the safety of the items kept by it.

How does it work? 1. You place money in a bank and the bank guarantees to return the money to you. 2. You are allowed to withdraw the money anytime. 3. Bank may charge you a fee for looking after your money and may pay hibah (gift) to you if it deems fit. 4. This concept is normally used in deposit-taking activities, custodial services and safe deposit boxes

Mudharabah (Profit sharing) Mudharabah is a profit sharing arrangement between two parties, that is, an investor and the entrepreneur. The investor will supply the entrepreneur with funds for his business venture and gets a return on the funds he puts into the business based on a profit sharing ratio that has been agreed earlier. The principle of Mudharabah can be applied to Islamic banking operations in 2 ways: between a bank (as the entrepreneur) and the capital provider, and between a bank (as capital provider) and the entrepreneur. Losses suffered shall be borne by the capital provider. How it works? 1. You supply funds to the bank after agreeing on the terms of the Mudharabah arrangement. 2. Bank invests funds in assets or in projects. 3. Business may make profit or incur loss. 4. Profit is shared between you and your bank based on a pre agreed ratio. 5. Any loss will be borne by you. This will reduce the value of the assets/ investments and hence, the amount of funds you have supplied to the bank.

Bai Bithaman Ajil BBA (Deferred payment sale) This refers to the sale of goods where the buyer pays the seller after the sale together with an agreed profit margin, either in one lump sum or by installment.

1. You pick an asset you would like to buy. 2. You then ask the bank for BBA and promise to buy the asset from the bank through a resale at a mark-up price. 3. Bank buys the asset from the owner on cash basis. 4. Ownership of the goods passes to the bank. 5. Bank sells the goods, passes ownership to you at the mark-up price. 6. You pay the bank the mark-up price in installments over a period of time.

Ijarah Thumma Bai (Hire purchase) Ijarah Thumma Bai is normally used in financing consumer goods especially motor vehicles. There are two separate contracts involved: Ijarah contract (leasing/renting) and Bai contract (purchase). The contracts are made one after the other as shown in the diagram

1. You pick a car you would like to have. 2. You ask the bank for Ijarah of the car, pay the deposit for the car and promise to lease the car from the bank after the bank has bought the car. 3. Bank pays the seller for the car. 4. Seller passes ownership of the car to the bank. 5. Bank leases the car to you. 6. You pay Ijarah rentals over a period. 7. At end of the leasing period, the bank sells the car to you at the agreed sale price.

Murabahah (Cost plus) As in BBA, a Murabahah transaction involves the sale of goods at a price which includes a profit margin agreed by both parties. However, in Murabahah, the seller must let the buyer know the actual cost for the asset and the profit margin at the time of the sale agreement. Musyarakah (Joint venture) In the context of business and trade, Musyarakah refers to a partnership or a joint business venture to make profit. Profits made will be shared by the partners based on an agreed ratio which may not be in the same proportion as the amount of investment made by the partners. However, losses incurred will be shared based on the ratio of funds invested by each partner. Wakalah (Agency) This is a contract whereby a person (principal) asks another party to act on his behalf (as his agent) for a specific task. The person who takes on the task is an agent who will be paid a fee for his services. Example A customer asks a bank to pay someone under certain terms. The bank is therefore the agent for carrying out the financial transaction and the bank will be paid a fee for its services. Qard (Interest-free loan) Under this arrangement, a loan is given for a fixed period on a goodwill basis and the borrower is only required to repay the amount borrowed. However, the borrower may, if he so wishes, pay an extra amount (without promising it) as a way to thank the lender.

Example A lender (bank) who lends Rs 5,000 to a borrower on Qard will expect the borrower (customer) to return exactly Rs 5,000 at a later date. Hibah (Gift) This refers to a payment made willingly in return for a benefit received. Example In savings operated under Wadiah (safe banks will normally pay their Wadiah depositors hibah although the accountholders only intend to put their savings in the banks for safekeeping.

Banking Scenario in India Banks in India are categorized into scheduled and non schedule banks. Scheduled banks consist of commercial and co-operative banks. India has 87 scheduled commercial banks with deposits worth Rs.71.6 trillion (US$ 1.21 trillion) as on 31 May, 2013. Of this, 26 are public sector banks, which control over 70% of Indias banking sector, 20 are private banks and 41 are foreign banks. There are 67,000 branches of scheduled banks spread across India. During the first stage of financial reforms, the country witnessed massive growth in the banking sector. As far as the present scenario is concerned the public sector banks which are the foundation of the banking system, account for more than 78% of the total banking assets. These banks face problems such as Non Performing Assets (NPAs), huge manpower and lack of technology. On the other hand, private sector banks are the leaders in Internet banking, phone banking, mobile banking and ATMs. Foreign banks are successful in India and are likely to grow in the future. The foreign banks have a total market capitalization of Rs.9.35 trillion (US$ 158.16 billion) as per the recent statistics. The share of New Private Sector Banks, Old Private Sector Banks, Foreign Banks, and Regional Rural Banks in aggregate deposits was 13.6%, 4.8%, 4.3% and 2.9% respectively.

Reasons for having Islamic banking in India Islamic Banking for Inclusive Growth: The structural changes in India during post independence are no parameter for equitable growth. Islamic banking can give inclusive growth along with control over inflation. It is well known that the SCBs extend debt finance. The interest component ipso facto becomes part of GDP. Interest rate sensitivity to inflation is well known. However, equity finance if extended with far lower costs of credit has potential to restrict inflation and there is enough evidence from West Asia in this regards. Then the distribution of dividend among equity holders helps in equitable distribution. In the agricultural sector, due to small loans, it has the capability of growth of infrastructure. Also Islamic banking can lend to small loans to unorganised sector due to its non-insistence on collateral as a precondition for lending even small sums of money. This would help to improve condition of states of desperate labour capital ratio like U.P. and Bihar. Islamic Banking and Financial Inclusion of Muslims: Muslims are the most disadvantaged community in financial sector according to Sachar Committee. Due to interest based deposit and credit from commercial banks, 80% of Muslims are financially excluded. The worker participation of Muslims in financial sector is also less; Muslims have just 0.78% and 2.2% employment with RBI and SCBs. Similarly in other financial institutions like SIDBI, NABARD Muslims presence is negligible. Hard to believe but true, that even Institutions like National Minority Development and Finance

Corporation (NMDFC) have no Muslim managers. According to RBIs report, Muslims loose around Rs. 63700 crores annually because they have a credit deposit ratio of 47% against national average of 74%. With 31% Muslims living under poverty line and 40% Muslim workers as own account workers, this big deficit can be covered by Islamic banking. It will not only please 150 million Muslims living in India, the second largest community of India, it will give advantage to attract trillions of Arab petro dollars. Corporate Sector and Islamic banking: The total investment in infrastructure in 200607 has been 5% of GDP, and it needs to be 9% by 2011-12. The total investment amounts to Rs 20,56,150crores for the 11th five year plan of which Rs. 1436,559 crores is supposed to be met from Public Investment while Rs. 6,19,591 from private investments. Islamic banking through equity financing can help to reduce the burden of keeping current account and fiscal account deficit under control. Islamic banking to counter terrorism: With greater inclusion of Muslim youths in financial sector, they can contribute in a better way. One of the main reasons of terrorism is poverty and Islamic banking can alleviate the condition. Also stringent norms of Islamic banking can help in stopping money laundering. Islamic banking and entrepreneurship: In his book Entrepreneurship and Indian Muslims, Dr. M. Akbar indicates the results of a study he conducted: most surprising was the positive association between the degree of religious observance and level of entrepreneurship. Higher orders of entrepreneurs displayed higher degree of religious observance, as they wanted to establish in their society that they were not only better entrepreneurs but were better Muslims as well. This positive correlation between entrepreneurship and

religiosity reflects well in Islamic banking among poor Muslims. It means the more the religious one person is the more likely that he will use the service of Shariah complaint banks. Investment framework favourable in India: Indias legal framework, which is the best in the region which protects foreign investors. Also India has abundant managerial and technical skill which will bring in more Arab money. Also the economies of other neighbouring Islamic countries like Pakistan and Indonesia have limited opportunities for the huge Arab money. Islamic banking and bankruptcy: As Islamic banking adheres to strict credit rating by disallowing indebted people to take on more debt, and as they go for equity financing, they screen the project more strictly, thus reducing the chances of bankruptcy. The credit rating under Islamic Finance has nothing to do with up and rise in asset values, instead it depends on actual business, thus also increasing entrepreneurial skills. Thus there is no fear of subprime mortgage under Islamic banking principles. Also due to right of ownership, in case of bankruptcy, the banks have higher chance of recovery.

Islamic Banking and Microfinance Under normal banking system, there must be trust between borrower and lender so that a transaction takes place. There are two components for that trust: first the applicants reputation as a person of honour and second the availability of collateral in case of default. But the poor people dont have any of the two for which they dont have access to credit market, except the loans from greedy moneylenders. With passage of time, the orientation of Islamic banking has shifted somewhat towards profit maximisation where

banks vie for countless billions of Arab petrodollars. But on a whole Islamic banking is not only refraining from charging interest. Its aim to contribute positively towards the fulfilment of the socioeconomic objectives of Islamic society inscribed in Maqasid al Shariah. What some Indian Muslim Funds in North India are doing Since 1960s, there have been efforts in India to run interest-free credit societies for the welfare of Muslims. In 1961, at Deoband, Jamiet-e-Ulema-e-Hind established the Muslim Fund Deoband, which inspired many similar funds to set up. Currently there are more than 100 Muslim funds in the country and many of them are member of the Federation of Interest Free Organization (FIFO). These funds are registered as Charitable Trusts. These funds provide financial assistance to needy people, both Muslims and non-Muslims on the basis of strong collateral in the form of ornaments. In the last 4 decades, their balance sheet have increased but they have not succeeded in following the Islamic norms as far as their lending and borrowing is concerned as their bulk earning consists of bank interest. The running of these funds is ambiguous, both in context of the Shariah and also in adopting the rules prescribed by Government. The fund managers are not much aware of the recent developments in the Islamic finance. These funds accepts collateral in the form of ornaments which they keep in their own lockers, thus the problem of safety is there. They have to devise way of recovering their costs apart from the fixed earning from bank. They have successfully inculcated the savings behaviour among low income Muslims by introducing daily collection system.

Stock Market and Islamic Banking The Indian stock markets could see huge inflows through Shariah-compliant funds as Islamic investors are lured by the countrys rising economy. These will also auger the need of Islamic banking system so that these funds can operate smoothly. The number of Shariah-compliant stocks in India is much higher than that of all Muslim countries put together, thus providing an immense scope for parking money, according to experts. For instance, 61 per cent if the listed companies in India are Shariah-compliant, against 57 per cent in Malaysia, 51 per cent in Pakistan and a mere 6 per cent in Bahrain. In terms of the number of stocks, 283 of Bombay Stock Exchanges BSE -500 constituents, 214 BSE small caps, 39 NSE-50 (Nifty) and 23 Sensex stocks are Shariah-compliant. There would be 8-10 funds in the Indian markets in 2-3 years and these would attract at least Rs 3,000 crores from domestic sources alone, he added. The German-based Baader Service Bank is coming in with a corpus amount of 30 million Euros for its First India Islamic Fund in Germany. The fund is awaiting FII status from the Reserve Bank of India. The Shariah stocks would encompass sectors such as telecom, IT/ITES, automobile, FMCG and real estate. Taurus Parsoli Ethical Fund the maiden Islamic fund in India -- The Fund, as the offer document states, is a five-year closed ended fund, which is not listed on the exchange. Mumbai S&P CNX Shariah on February 20th 2008 announced the launch of S&P CNX 500 Shariah and S&P CNX Nifty Shariah in a move to capture the movement of Shariah

compliant stocks in the Indian stock market for Islamic investors. The S&P CNX 500 Shariah comprises 263 companies while the S&P CNX Nifty Shariah comprises 40 firms. Indian banking laws and Islamic banking Indian Banks are regulated by the Indian Banking Regulation Act (1949), The Reserve Bank of India Act (1935), The Negotiable Instruments Act and the Cooperative Societies Act (1866). Some of the obstacles of Islamic banking regarding regulations are: a) Section 21 of the Banking Regulation Act requires payment of interest which is against Shariah. b) Section 5 & 6 of Banking Regulation Act disallows banks to enter into any profit sharing and partnership contract the very basis of Islamic banking. c) Section 9 of the Banking Regulation Act prohibits banks to own any sort of immovable property apart from private use this is against Ijarah (for home finance). Thus to allow Islamic banking considerable amount of changes on law have to be made. One way is to keep the current legislation applicable for existing banks and amend specific legislations applicable for interest free banks. A new regulatory body will oversee them and help them make and enforce accounting and auditing standards. One specific change to be made includes the requirement that NBFCs would have to invest at least 15% of their total investment in interest based Government securities. An easy alternative is to allow them invest in equity of public listed companies. Another change required is the heavy taxation of return on equity investment as opposed to interest income.

Other hindrances in the way of Islamic banking Standards non-uniformity: The interpretation of Shariah differs between regions and even between institutions. This gives rise to unequal products. Also regulatory oversight needs to be developed further. Manpower shortage in Islamic Banking: With Islamic banking at its nascent stage, there is acute shortage of trained Islamic bankers as well as scholars. Recently three institutes offering Islamic finance and management has been set up in Kerala, Hyderabad and Bhubaneswar, offering postgraduate diploma in Islamic banking and finance. Also Aligarh Muslim University is planning to open such a course. Need of more products: The industry needs to work on innovation. Due to many rules, the instruments tend to become more complex and there are many instruments like corporate treasury is missing Islamic banking system for developing nations like India Sources of fund: Islamic banking over the years has identified two kinds of accounts: Demand deposit or transaction accounts which doesnt pay any interest and may even charge interest. Although it is illegal under Islamic law to pay interest, one can be compensated for maintaining purchasing power. This can be paid monthly or quarterly based on wholesale or consumer price index. The other type is investment account (Modarabeh) where the bank provides equity capital to companies. The account holders become indirect shareholders with no guarantee on the value of their account. This set of accounts resembles mutual fund. Also it helps generate huge amount of information generation of credit history. The transaction account will have the most senior claim against the bank.

Investment of funds: Mainly in equity contracts. Debt can be given only when the bank has great deal of confidence in the project or management or the liquidation value of the collateral. By this way the banks will not strictly focus on equity participation; it will offer conventional deposit accounts which has safety and return; this will help in money generation and satisfy the transaction need of economy.

Future Outlook The country where the Muslim population is more than Pakistan, after 60 years of Independence should think about reform in banking sector to introduce Islamic banking. Raghuram Rajan Committee on Financial Sector Next Generation Reforms made a reference to this aspect. There has never been any public committee analyzing the effects of Islamic banking in India. This can be attributed to the fact that Muslims in India have never demanded Islamic banking in a prominent manner. And we never delivered it to them for which Muslims in India have only 9% of total bank accounts although they make up 12% of the population. Islamic banking can boost Indian economy by boosting real sector economy rather than only financial sector. There are many advantages of Islamic banking but the main reason is that the Muslims are so poor today that we truly owe it not only to our forefathers and our current generation to make things better, we also owe it to future generations of Indians. There are certain costs in implementing Islamic banking, but the expected value of such a reform is quite high. Many new Shariah compliant financial instruments are being developed throughout the world from which Indian regulators can learn and inculcate. India should take help to make regulatory framework from foreign banks which have operations in Islamic banking

environment. Taking all these points into consideration, India should open up for Islamic banking so that Indian Muslims are benefitted and huge amount of FDI from Muslims worldwide comes in the country. Steps taken by Indian Government xperts argue that Islamic banking will mobilise enormous capital held by devout Muslims who sparingly participate in the conventional market. The Raghuram Rajan Committee on Financial Sector Reform (2008) also considered interest-free banking, and by 2013, the global market for sharia-compliant assets has risen to $1.6 trillion. Specifically for India, this means institutional money from the Middle East and Southeast Asia, as well as private wealth held by Indian Muslims in and out of the country. Given the number of Indian expatriates in these regions, Islamic banking holds an enticing opportunity for fuller market capitalisation. Sharia-compliant schemes have already shown promise in India - Tata Core Sector Equity Fund, launched in 1996, was tailored to assuage Muslim inhibitions on riba. Furthermore, it would be an added bonus if Islamic banking reduces dead-end investments in gold and jewellry.

The Reserve Bank of India has recently as given a nod to the Kerela Government to start the first Islamic Banking operations in the country he he Kerala government has got a go-ahead from the to launch a financial institution following the principles of Islamic finance.

Cheraman Financial Services Limited (CFSL) will be floated by Kerala State Industrial Development Corporation to function as a non-banking finance company (NBFC). A

formal announcement on CFSL, the latest incarnation of Al Baraka Financial Services, was made on Saturday.

Industries minister PK Kunhalikutty and CFSL chairman P Mohamad Ali told reporters here that the firm would function as a non-banking finance company with an authorised capital of Rs 1,000 crore.

This is xpected t benefit the 177 million muslims in India , the largest Muslim minority poplation in the world.

LEGAL CHALLENGE Last year, the RBI directed Kochi-based Alternative Investments and Credits Ltd (AICL) to stop its non-interest NBFC business almost a decade after the firm was launched. This prompted an ongoing legal challenge by AICL. "The grant of an NBFC licence should have an impact on the AICL proceedings and there are good chances that the matter may get settled soon," said Suprio Bose, Mumbai-based lawyer at Juris Corp, a law firm which previously represented AICL. "The event reflects a significant and welcome change in RBI's attitude towards shariabased NBFCs and sets a precedent for others to follow suit." However, many analysts think that unless and until full-fledged Islamic banks are permitted in India, an Islamic finance sector will find it hard to develop.

"I don't think there is going to be a rush for NBFC applications. RBI's attitude towards the sharia-compliance concept is yet to be tested," said Shariq Nisar, director of research and operations at Mumbai-based Taqwaa Advisory and Shariah Investment Solutions. Running a sharia-compliant financial institution under Indian regulations is still difficult and other firms are likely to stay on the sidelines pending the success of existing schemes before deciding to join in, he added. Islamic equity and venture capital products have attracted little demand in India and NBFCs could face the same fate, said Nisar. "NBFC business overall has been declining over the years." The RBI issued guidelines for NBFCs in June, cracking down on debt issuance by an industry that relies heavily on capital markets to fund its business but has faced less regulatory oversight than banks. According to central bank data, credit extended to NBFCs increased by 1.9 percent from a year earlier in June, compared with an increase of 43.9 percent in June last year. There are over 12,000 registered NBFCs in India. A handful of politicians have been lobbying for years to start Islamic banking in India, but they have met strong opposition from bureaucrats in the finance ministry and banking circles. Some politicians, especially from the main opposition Bharatiya Janata Party, say they fear Islamic banking could be used by militants and might strengthen the hold of clergy over India's Muslim community.

DEVELOPMENT OF ISLAMIC BANKING IN INDIA 3.1 HISTORICAL DEVELOPMENTS The work on Islamic finance in India has started in the beginning of the 20th century. According to Shariq Nisar, it can be classified as literary and practical. The literature available was primarily in Urdu, the rest being either in English or in Arabic. The first book published in English on the Islamic finance was Islam and the Theory of Interest in 1946 written by Professor Anwar Iqbal Qureshi of Usmania University Hyderabad. On the practical side, Anjuman Mowudul Ikhwan a welfare association, established in 1890 by a famous alim of Hyderabad. This was later managed by his son Syed Mohammad Badshah Husaini. The society collected donations and skins of sacrificed animals from the public and provided interest free loans to weaker section (Nisar, 2002). In north India, the Muslim Fund Tanda Bavli, Rampur was established in 1941. Unfortunately, the fund was closed due to partition of India. After about fifteen years since partition, the Muslim Fund Deoband (MFD) was established in the year 1961, and is still operating. Muslim Fund Najibabad (MFN) was established on the model of MFD in 1971. In 1990, MFN floated a subsidiary, Al-Najib Milli Mutual Benefits Ltd. (Bagsiraj, 2002a). In western India, the Patni Co-operative Credit Society, Surat (Gujarat) was established in 1938 and is still in operation to provide interest free loans to its members without any collateral security or service charges. This region showed great efforts to establish a cooperative credit society. The result of the efforts was recognized in the form of establishment of the Modern Education Social and Cultural Organization (MESCO) by a few college students of Bombay (now Mumbai) in the year 1968. MESCO led to the

establishment of Baitun-Nasr Urban co-operative credit society (BUN), commenced functioning in the year 1973. Restriction on the operation of the society beyond the geographical boundary of Bombay and certain other restrictions leads to the formation of Barkat Investment Group (BIG) in the year 1983 (Nisar, 2002). BIG and Tata Mutual Fund came together in 1996 to launch a mutual fund scheme especially designed for Muslims in view of their inhibitions about interest, though it has never being regarded as Shariah compliant fund as no Shariah advisor involved for screening of the fund. The scheme named Tata Core Sector Equity Fund. But, the fund name was changed four times due to various reasons in past and presently known as Tata Ethical Fund (Adajania, 2011). 3.2 RECENT DEVELOPMENTS Over the last decade, a number of significant changes have occurred in the Indian banking sector with a view to raise the efficiency and productivity of banks as a whole. 3.2.1 ANAND SINHA COMMITTEE With an objective to reach the banking system to more people in India, Reserve Bank of India (RBI) had constituted a committee in June 2005 to examine financial instruments used in Islamic banking headed by Mr. Anand Sinha, deputy director of RBI. Two observations were made by the committee: 1. Appropriate modification should be made in banking regulation act 1949 along with separate rules and regulations. 2. Taxation proposition have to be examined. But, the idea of Islamic banking was rejected by RBI saying that it is not feasible for Indian banks to undertake Islamic

banking or to allow theirbranches to carry out Islamic banking operations abroad without amendments in current related banking and other laws. 3.2.2 RAGHURAM RAJAN COMMITTEE In 2008, the Planning Commission of India appointed a committee, headed by International Monetary Fund (IMF) former chief economist, Raghuram Rajan, to recommend various ways to take the countrys financial sector reforms forward. Raghuram Rajan committee has made two major recommendations. recommendations have given a boost to the demand of Islamic banking in India. 1. Committee recommended that measures should be taken to permit the delivery of interest free finance on a larger scale, through the banking system and this is in accordance with the objectives of inclusion and growth through innovation. The committee affirms that interest free banking is currently provided in a limited manner through Non Banking Financial Companies (NBFC) and cooperatives. 2. The committee believed that it would be possible only through appropriate measures to create a framework for such products without any adverse systemic risk impact. 3.2.3 PARLIAMENTARY COMMITTEE Apart from the two important committees, there was another important development which has provided strength to the demand of Islamic banking and finance in India. It was revealed from the report of the Parliamentary committee set up by Prime Minister, headed by Mr.Rahman Khan, Ex-deputy chairman Rajya Sabha has recommended to create a Hajj pilgrimage fund based on Shariah principles. Lack of Shariah compliant investment opportunities in India has discouraged Muslims to invest, not only through These

banks but also through stock market. The Securities and Exchange Board of India (SEBI) has given approval for Indias first official Shariah compliant mutual fund scheme Taurus ethical fund in 2009. The Taurus Mutual Funds and Parsoli corp. had applied the funds offer document in October 2007, initially SEBI had some reservations on the fund, as it targeted a particular community (Islamic Finance News, 2009). 3.2.4 KERALA GOVERNMENT INITIATIVE In 2010, Kerala State Industrial Development Corporation (KSIDC), a wholly owned Kerala state government company, got into an agreement with Al Barakah group to offer Shariah compliant finance to the Muslim community. In the proposed Islamic financial institution, KSIDC holds 11% stake. However, The government order was challenged by Janata Party leader Subramanian Swamy in the Kerala High Court arguing that association of government agencies in setting up Islamic investment company goes against secular principles preserved in Indian constitution and was stayed on grounds of violation of Article 14, 25, and 27. In February 2011, Kerala High court has dismissed the petition filed by Subramanian Swamy and maintained setting up of an Islamic investment company. 3.2.5 PRESENT SCENARIO In June 2012, Chairman of national commission for minorities has proposed to Ministry of Finance (MoF) to take a fresh account of the matter after RBI has again rejected the possibility of Islamic banking in India. Consequently, MoF has asked the RBI to examine the possibility of Islamic banking model a part of Indian banking system. In October 2012, RBI governor confirmed their discussion with MoF on amendments in existing laws to accommodate Islamic banking in India (Unnikrishnan, 2012). This positive move

of RBI certainly paves a path and gives an insight of the future of Islamic banking in India. India has strong ability to emerge as a potential market for Islamic banking, provided there is supportive political environment and increased awareness among people in India as a whole. Presently, there is no Islamic bank in India except few Shariah compliant funds and several other Islamic financial institutions and credit cooperative societies. India is in prime need of an Islamic bank because as per Sachar committee report, about 80% Indian Muslims are financially excluded due to interest based deposit and credit from conventional banks. In addition to that, RBI reports that Muslims have a Credit Deposit Ratio (CDR) of 47% against the national average of 74% (Majumdar, 2008). It is to note that CDR is a monetary tool which maximizes the credit flow and ensures better deployment of credit. As per the RBI, if the CDR is low, the weaker sections will be the most affected along with other borrowers. Hence, the lesser credit flow from banks to Muslims would widen the gap between the weaker sections and economically sound sections.

4. PROSPECTS AND BENEFITS OF ISLAMIC BANKING IN INDIA

The prospects of Islamic banking in India are bright; with reference to demographic structures and the benefit of Islamic banking in itself. 4.1 DEMOGRAPHIC ADVANTAGE India is at an advantage due to its Muslim population. Islamic banking has been augmented in Asia-Pacific region, now account for 60% of the global Islamic banking market. Despite its rise in the rest of the region, the adaptation in India of the same has been low. It is very surprising mainly because according to Pew Research Center, India is the 3rd largest Muslim populated country after Indonesia and Pakistan, having approximately 177 million Muslims, which is 14.6% of total Indian population (Grim and Karim, 2011). According to India census 2001, Muslim population enumerates at over 138 million. In terms of the state wise distribution, the majority of the Muslims in India are based mainly in four states Uttar Pradesh, Bihar, West Bengal and Maharashtra with at least 10 million Muslims each. Uttar Pradesh has the largest Muslim population in India with around 30 million Indian Muslims living, as shown by the census 2001. The other states with a considerable Muslim population are Kerala, Andhra Pradesh, Assam, Jammu and Kashmir and Karnataka with a population of between 5 to 10 million Muslims each. Rajasthan, Gujarat, Madhya Pradesh, Jharkhand and Tamil Nadu have Muslim population of between 3 to 5 million each. Delhi, Haryana and Uttaranchal have 1 to 2 million each.

TABLE 1: NUMBER OF DISTRICTS BY MUSLIM POPULATION SIZE AND CONCENTRATION, CENSUS 2001

Percentage of Muslims in the total population of the district 75 or more 50 or more but less than 75 25 or more but less than 50 10 or more but less than 25 1 or more but less than 10 Less than 1 Total

Number of districts 9 11 38 182 276 77 593

A report on social, economic and educational status of the Muslim community of India (Sachar, 2006).

According to district wise distribution, Committee reports that out of 593 districts in India, 20 have Muslim majority. Nine have over 75% Muslim population; these include Lakshadweep and eight districts in Jammu and Kashmir as shown in table 1. The other 11 districts have between 50 to 75% Muslim population. These are extended in

following states: 6 districts of Assam, 2 districts of Jammu and Kashmir, as well as 1 district each for West Bengal, Bihar and Kerala. Nearly 18 Million people lived in these districts, making about 13% of Indias Muslim population as shown in table 1 (Sachar, 2006). A further 38 districts have a noteworthy Muslim population of between 25 to 50%. These are scattered in a number of states as follows. Uttar Pradesh 12 districts, West Bengal 5 districts, Kerala 5 districts, Assam 4 districts, Bihar 3 districts, Jharkhand 2 districts, Delhi 2 districts and 1 district each in Andhra Pradesh, Haryana, Jammu and Kashmir, Uttaranchal and Pondicherry. These districts accounts for around 30 Million people, about 22% of the Muslim population.182 districts have a significant Muslim population between 10 to 25%. These districts accounted for nearly 47% of the Muslim population, around 65 Million people. In about 276 districts Muslim population is between 1 to 10% of the population. For the remaining 77 districts Muslim population is between 0 to 1% and these 353 districts have nearly 25 Million people, about 18% of India s Muslim population. The demand for Islamic banking by Muslims in India is supported by a survey conducted by Bagsiraj (2002) which revealed that 80% urban Muslims in India are all set to deposit or invest on Profit Loss Sharing (PLS) basis and 67% urban Muslims are willing to borrow from Islamic financial institutions.

4.2 SIGNIFICANT FLOW OF FUNDS

The absence of Islamic banking is an obstacle to the flow of substantial funds into the market. According to Shariq Nisar, Director, TASIS, there is approximately INR 50 billion unclaimed interest in Kerala state alone. People generally choose to invest their money in gold or jewellery, which is regarded as worst kind of investment. There are at least 300 Islamic societies which accept deposits and lend money, but can t make a business of it because of the Shariah prohibition of interest. And these Islamic societies cannot convert themselves into bank because the regulation restricts interest free banking. Some of these societies have collected more than INR 2 billion in interest-free deposits, but they do not have any opportunity to invest the fund (Sampath, 2008). 4.3 EVADING PETRO-DOLLAR LOSS Islamic banking is expected to benefit Indian government through diplomatic rewards in financial dealings with Muslim dominated nations. Particularly, trillion dollars finance from Gulf Cooperation Council (GCC) countries can be attracted. The GCC countries interest in venture capitalism and real estate financing can help in infrastructure development in India. In 11th five year plan the expected total investment in infrastructure is to be INR 2,056,150 crores (1 crore = 10 million). Out of which INR 1,436,559 crores are expected to be met from public investment and Rs.619,591 crores from private investments (Planning Commission of India, 2008). Due to absence of Islamic banking, India is losing millions of petro-dollars which are now moving to countries like UK, China, Singapore, Malaysia and Japan.

4.4 LARGE NUMBER OF SHARIAH COMPLIANT COMPANIES

According to Ashraf Mohamedy, MD, Idafa investments, there are almost 80% of the Indian companies are Shariah compliant to the extent their business in India is concern. In the year 2009, SEBI has given licenses for Shariah compliant portfolio products. In 2011, National Stock Exchange (NSE) with Ratings Intelligence Partners (a London/Kuwait-based global Islamic consulting company) has launched NSE Shariah Index S&P CNX 500 Shariah. Whereas, in the same year Bombay Stock Exchange (BSE) with Taqwaa Advisory and Shariah Investment Solutions (TASIS) has launched a Shariah Index known as BSE TASIS Shariah 50. According to Shariq Nisar, the Director of TASIS, BSE has the highest number of Shariah compliant companies across the globe. 4.5 PROJECT FINANCING FOR ECONOMIC GROWTH The financing in Islamic banking concerns more with the viability of projects instead of credit worthiness of borrowers. In other words, Islamic banking is financing projects which link to the economic growth. According to Siddiqi and Khan (2003) interest based loans give advantage to credit-worthy individuals and do not necessarily finance profitable projects. Conventional banking system priorities credit worthiness of the client rather than expected profitability of the project. At times promising projects might fail to receive finance if it comes from one who does not have a guarantee to support the project. The emphasis on equity and profit sharing which is the key aspect to determine whether a project is worth financing is a valuable asset of implementing the Islamic banking in India. Furthermore, the inadequate capital investment in unorganized sector can receive a boost through equity finance promoted by Islamic banking. This sector normally lacks

collateral, hence are not eligible for debt financing. Islamic banking can overcome this situation and thus can lead to the next revolution in agriculture and unorganized sector. 4.6 SAFEGUARD AGAINST ECONOMIC DECLINE As per the global downturn scenario, Islamic banks are a solution to the economic decline. One of the important factor which leads to international financial crisis are innovative financial products, transactions and short selling. Islamic banks are shielded from interest based transactions because Shariah prohibits interest as well as short selling. 4.7 INCOME DISPARITY REDUCTION According to United Nations Development Programme (UNDP) human development report, India needs to draw attention towards increasing income disparity as they reported it to be 36.8, quite close to worlds average and with a rising trend (UNDP, 2011). This wide income disparity in its severe ravenous from has leato widen the divide in society. Muslims who follow Shariah do not avail credits and remain isolated. Hence, Islamic banking would assist in the upliftment and the disparity reduction. 4.8 INCREASED PARTICIPATION IN STOCK MARKET It is expected that the introduction of Islamic banking and development of Islamic funds would lead to addition of new stock trading accounts, thereby giving a rise in the stock market. In line with Dow Jones' Islamic index, similar Indian Islamic indexes like BSE TASIS Shariah 50 and S&P CNX 500 Shariah will attract funds from Muslims wishing for Shariah compliant investments. 4.9 ISLAMIC WINDOW FOR BUSINESS DIVERSITY

A growing number of commercial banks around the globe are considering the prospects of offering Islamic financial products. Banks are not only planning to offer services to a growing Muslim population, but also motivated to tap the growing global investors attracted to Shariah-compliant products. Considering the idea, Indian banks may want to explore the potential of this market, and hence may be interested in launching a pilot project. There have been arguments that banking based on religion has limitations to spread in a secular country like India; which is not true. Britain, with less than 2 million Muslims population, already has 6 Islamic banks, of which 3 were set up in 2008. According to Ali Ravalia, associate, UK Financial Services Authority, people have started to realize that Islamic banks are not a threat but an opportunity for economic growth. In addition to the large and available Muslim population, Islamic banking is currently beginning to catch the attention of non-Muslim customers, who are interested in alternative way of banking. Indeed, a growing number of non-Muslims are turning towards Islamic banking; as customers are frightened by chaos in the western banking system. Secondly, this sector is considered safer and well connected to the real economy. According to Fiorina (2008) Islamic banking will be benefited from the new customers interest and grow even more quickly than it recently did. In addition, corporate giants like Tesco (UK) and Toyota (Japan) have used Islamic financial instruments to fulfill capital requirements (DiVanna and Sreih, 2009). This proves that not only individuals, but also corporate giants have showed confidence in Shariah compliant financial instruments 5. CHALLENGES OF ISLAMIC BANKING IN INDIA

Despite the prospects and benefits of Islamic banking in India, various challenges and obstacles for introducing Islamic banking prevails. India is a secular country and its banking system is fully based on conventional banking. India has 88 scheduled commercial banks (SCBs), 26 are nationalize banks (Government of India holding a stake), 21 are private banks and remaining 41 are foreign banks. These SCBs have a combined network of over 69,160 branches and 60,153 ATMs. Although, several institutions are operating on the Shariah principles but they are treated as NBFCs which functions like a bank. However, NBFC does not accept demand deposits and cannot issue cheques. Following are the major challenges to be faced by Islamic bank in India. 5.1 ADVERSE REGULATORY FRAMEWORK One of the major challenges is the regulatory framework governing banks in India. The lack in accounting, auditing, and credit analysis standards for Islamic banks exist until now. Significant amendments in regulations are to be done, such as stamp duty, banking regulations act, corporate and other tax regulations to evolve a different system of regulation and control. None of these laws provide a room for the possibility of an Islamic banking system in India. Countries such as France, Germany, Switzerland, Singapore, Japan, Malaysia and the UK have adopted Islamic banking and amended the regulatory framework to be favourable to Islamic banking. The Indian government can choose and apply any model which is reasonable to the Indian scenario. The RBI appointed Anand Sinha committee to elucidate if Islamic banking can be introduced in India. The committee evaluated options and concluded that Islamic banking cannot be offered by Indian banks as well as the overseas branches of local

banks under the present legal framework. Except for a basic current account, almost no other banking product in India can be modified to meet the Islamic banking requirement. Few Indian banking laws extracted from Indian banking regulation act 1949 are the barriers in the ways to Islamic banking are listed as below: 1. Al Wadiah (for saving bank account): Section 21 requires payment of interest on such deposit. 2. Mudarabah (for term deposit or investment): Section 21 disallows such products where the bank can invest the money in equity funds. 3. Mudarabah and Musharakah (for project finance and SME credit): Sections 5 and 6 indicate the forms of business a banking company can undertake, and does not allow any kind of profit-sharing and partnership contract. 4. Ijarah (for leasing): As against Islamic banking where the banks owns the asset and hold the title, Section 9 prevents the bank from any sort of immovable property other than private use. 5. Istisna (for home finance): Besides the usual curbs on acquiring immovable property, offering Islamic banking products may not be bankable due to stamp duty, central sales tax and state tax laws that will apply depending on the nature of the transfer. 5.2 INTERPRETATIONS OF SHARIAH PRINCIPLES The second major challenge in introducing Islamic banking in India involved the varying interpretations of Shariah principles across regions, countries and even within the same country. Shariah council, an independent bank appointed panel of scholars determines the Islamic practice and its interpretation. Therefore, based on the interpretation of what

is considered Islamic in Bahrain may not be accepted in India. This absence of uniform standards might affect the banks ability to duplicate and apply Islamic banks and products across geographies and its expansion to other states. 5.3 INVESTORS ASSURANCE The third challenge is captivating investors assurance. The conventional banks have the facility of deposit insurance and credit guarantee which develops sense of security and confidence among investors. The investors may demand for the same from Islamic banks. 5.4 LOW LITERACY RATE The fourth challenge in introducing Islamic banking can be examined from demographic characteristics of Muslims in India. One of it involved the education status of the Muslims in India. For instance, census 2001 shows that the literacy rate among Muslims is 59.1% which is below the national average i.e. 65.1%. It has also been observed 26% of those aged 17 years and above has completed high school but again this percentage below national average accounted 17% of Muslims. While 7% of those aged 20 years and above are graduates, this percentage is less than 4% amongst Muslims. Illiteracy prevails among Indian Muslims which is the major cause of ignorance towards religious regulations and aspects. 5.5 NON-AVAILABILITY OF BANKING FACILITIES In addition to low literacy rate, the Sachar committee report shows that the access of bank credit to Muslims is low and inadequate (Sachar, 2006). The average size of credit is also meagre and low compared with other Socio-Religious Categories (SRCs) both in Public Sector Banks and Private Sector Banks. The situation is same with respect to

finance from specialized institutions such as Small Industries Development Bank of India (SIDBI) and National Bank for Agriculture and Rural Development (NABARD). The data from census 2001 reveals that the percentage of households availing banking facilities is much lower in villages where the share of Muslim population is high. One of the reasons for such an outcome could be non-availability of banking facilities in these villages. The report concluded that the financial exclusion of Muslims has far reaching implications for their socio-economic and educational upliftment. It was suggested that to empower Muslims economically, it is necessary to support self-employed persons as it is the main source of income to Muslims. This can be done through ensuring flows of credits to the Muslims in India. The committee observes that some banks use the practice of identifying negative geographical zones on the basis of certain criteria where bank credit and other facilities are not easily provided. Such practice is referred to as red lining in the United States. It is possible that in some of these areas the share of Muslim population is high and yet the community is not able to benefit fully from the banking facilities. 6. SUGGESTION Indian government should allow conventional banks to open an Islamic banking window for early development of Islamic banking system. Islamic window is a facility within a conventional bank through which customers can make use of Shariah compliant products (Kamaruddin et al., 2008). The concept of Islamic banking window has been successful in Malaysia, Pakistan and Hong Kong. Currently, India has strong setup with 88 SCB and these banks have a joint network of over 69,160 branches. According to Khan and Ahmad (2003) to function in globalised economy, banks have to meet

international standards. Islamic banks have to learn a lot from conventional banks, especially on their managerial skills, financing tools and transparency standards. The conventional banks will not only provide infrastructure to Islamic banking window but will also provide the initial experience needed to establish the same. Considering large network of conventional banks in India, India is suggested to start Islamic banking by opening Islamic window to reach the prospective customers. Opening an Islamic window will require the bank to establish the suitable measures to avoid the mixing of Islamic and conventional funds. Once a conventional bank has run an Islamic window and gathered a substantial clientele base for its Shariah compliant products, it may choose to launch a full-fledged Islamic bank. Indian government may consider Malaysian Islamic window as a role model. The first Malaysian Islamic bank was Bank Islam Malaysia Berhad established in 1983 did not get anticipated success. Therefore, in 1993 the government allowed conventional banks to offer Islamic banking services through Islamic window assuming it will be more effective and efficient in increasing the number of Islamic financial institutions and lowering cost within short span. The effectiveness of Islamic window is proven as it has leaded to an improved performance and enhanced efficiency of banking industry (Mokhtar et al., 2006). In addition to that, for the growth of the Islamic banking in India, proper amendments in the different acts and regulations should be made to accommodate Islamic banking. This is to ensure that Islamic window division can work according to Shariah principles within the existing setup. So that, funds at the disposal of such mixed banks cannot be pulled from Shariah prohibited earnings.

7. CONCLUSION India has a huge market potential for Islamic banking. The growth of Islamic banking in Southeast Asian countries like Malaysia and Singapore shows it as a viable option for India. The entry of Islamic banks is positive in terms of growth, product innovations and financial inclusion and may encourage the adoption of best practices among the present banks as: 1. Islamic banking can help in eradicating poverty by lowering down the economic disparities as there is no interest obligation on the part of the unfortunate borrowers. 2. It can induce the habit of savings among people and create the financial insertion required in India. Islamic banking draws finances from both Muslims and nonMuslims alike. 3. Islamic banks offer financial instruments that are not only profitable but also reasonable and are ethically fair. 4. Islamic banks would give advantage to entrepreneurs who have profitable proposals but lack collateral. For these, Indian government should look for the opportunities and take a stand in introducing Islamic banking. However, there are challenges to be faced to introduce Islamic banking in India: 1. The Indian banking regulation acts are desired to be duly modified to launch Islamic banking in India. 2. New standard accounting practice has to be developed.

3. Lack of experts in the field of Islamic finance, differences in interpretation and compliance with Shariah makes the situation more challenging. 4. The main challenge is a favourable political environment, presently which goes against growth of Islamic Banking in India. In conclusion, the initiatives in establishing Islamic banking in a secular nation of India may face various political, legal and societal constraints. However, the support of the government in implementing Islamic banking would bring various benefits to India.

Research Methodology.

due to its economic growth and Muslim population. However, until now, Takaful has not been introduced yet. This research makes an initiative to explore on the potential of Takaful market in India. This study follows the SWOT analysis approach to find out the viability of takaful in India. Since the research is an exploratory study, the primary data such as the questionnaire and interviews are used. The purpose of distributing questionnaire is to examine the perception Muslims and Non-Muslims towards awareness, acceptability, prospects and challenges of Takaful in India. In addition, Shariah advisors, consultants and insurance operators contacted in order to know the strengths, weaknesses, opportunities and threats that might be faced if Takaful is introduced in India. Secondary data includes various articles, books, journals that will contribute in drafting out a comprehensive picture about the possibilities, challenges

and prospects of Takaful in India. Quota sampling method is adopted and Sekaran and Bougie (2010) recommends this sampling method for the exploratory research. Descriptive statistics is adopted. Profile of the respondents
Table 1 Parameters Gender Male Female Respondents Age 20 - 30 31 - 40 41 - 50 51- 60 60 & above Occupation Self Employed Government sector employees Private sector employees Others Personal Income 10,000-20,000 21,000-30,000 31,000-40,000 41,000-50,000 51,000 & above No Income

Muslims 66 38 28 Muslims 12 16 20 8 10 Muslims 30 12 13 11 Muslims 5 8 7 10 30 6

% 66% 58% 43% % 18% 24% 30% 12% 15% % 45% 18% 20% 17% % 8% 12% 11% 15% 45% 9%

Non Muslims 70 45 25 Non Muslims 15 20 24 9 2 Non Muslims 25 15 20 10 Non Muslim 6 10 10 15 25 4

% 70% 64% 36% % 21% 29% 34% 13% 3% % 36% 21% 29% 14% % 9% 14% 14% 21% 36% 6%

Overall 136 83 53 Overall 27 36 44 17 12 Overall 55 27 33 21 Overall 11 18 17 25 55 10

% 68% 61% 39% % 20% 26% 32% 13% 9% % 40% 20% 24% 15% % 8% 13% 13% 18% 40% 7%

Table 1.2 Table 2 Muslims Religion Hindus Muslims Christian Others Population 35 66 20 15 % 26% 49% 15% 11% Retired Housewife Student Government employees Private employees 5 4 2 12 13 Non Muslims 6 2 2 15 20 Overall 11 6 4 27 33

Mumbai was selected as the area of study. 200 questionnaires were distributed to Muslims and Non-Muslims population equally via email or hard copy. Out of 100 questionnaires distributed to Muslims, 66 people responded the questionnaire and hence, the respond rate for the Muslims was 66%. In the case of non-Muslims, out of 100 questionnaires, 70 responded and thus, the respond rate from non-Muslims was 70%. Therefore, overall respond rate was 68%. When the gender of the respondents is examined; most of the respondents are male since 60.4% belong to the male. It might be due to the fact that targeted group is working people and according to the Indian culture, majority of the working people are male. The age range of the majority of respondents is between 31 to 50 years and 69.3% of the respondents belong to it. When the education background of the respondent is examined, most of them are master degree holders, followed by degree, diploma, non- degree and Ph.D. holders (refer to Table 1). In the case of religion, highest percentage of the respondents is Muslims (65.1%) and second highest respondent group were Hindus (25.5%). The employment status showed that 36.6% were in government section, 34.5% in private section, 20.4% were self-employed, 5.1% were retirees and 3.3% were student. As most of the respondents are employed, income for the majority is between Rs.10, 001 and Rs. 40,000.

Questions 1. Have you heard about Islamic banking? Q2. Are you aware that conventional banking products are not Shariah compliance? Q3. Are you aware that Islamic banking is not only for Muslims but also for non -Muslims? Q4. Do you know about the Shariah principles offered in Islamic banking products? Q5. Do you think Islamic banking should be introduced in India? Q6. Do you think Islamic Banking will affect the country positively or negatively? Q7 If introduced in India, will you avail the services offered by Islamic Banks? Q8. Will it give rise to any kind of political issues or minority issues in the country? Q9.Do you invest/save or deposit your money in conventional banks? Q10 Are you aware that Banking laws do not comply with the Islamic Banking rules laid down by Islam? Q11. Name any one such issue that will be eradicated through the introduction of Islamic Banking? Q12. Name any one such issue that will create problems through the introduction of Islamic Banking?

Yes/No Yes No Yes No Yes No Yes No Yes No Yes No Yes No Yes No Yes No Yes No

Muslims 66 0 66 0 43 23 38 28 66 0 50 16 66 0 16 50 15 51 56 10 attract Muslim investments can become a political issue

% 100% 0 100% 0 65% 35% 58% 42% 100% 0% 76% 24% 100% 0% 24% 76% 23% 77% 85% 15% more options for getting loans amendment of banking laws

Non Muslims 48 22 48 22 17 53 27 43 38 32 35 35 28 42 28 42 70 0 62 8

% 69% 31% 69% 31% 24% 76% 39% 61% 54% 46% 50% 50% 40% 60% 40% 60% 100% 0% 89% 11%

Overall 114 22 114 22 60 76 65 71 104 32 85 51 94 42 44 92 85 51 118 18

% 84% 16% 84% 16% 44% 56% 48% 52% 76% 24% 63% 38% 69% 31% 32% 68% 63% 38% 87% 13%

Riots & terrorism

job creation

pooling of foreign funds from Gulf countries into the country

create religious barriers

may give rise to terrorist funding

cannot guarantee authenticity of the products and services offered by Islamic banks