Islamic Banking

Interest-free Islamic banking is a worldwide trend with over 500 Islamic banking institutions operating all over the
world from Africa and Europe to Asia and Australia. Islamic Bank is the bank practiced as per Islamic principles called
Shariah. The Islamic law prohibits interest on loans and deposits. The argument against interest as per Muslim law is
that money is not a commodity and profits should be earned on goods and services only and not on the control of
money. Islam as a religion prohibits charging of interest and practice of gambling, ambiguity and concealment of
information, deceit and fraud, hazardous activity and hoarding, etc. in financial transaction between persons and
institutions with a view to promote justice, equity and excellence in financial affairs of the society. It operates on the
principle of sharing both profits and risks by the borrower as well as lender. The depositor cannot earn a fixed return in
the form of interest as in conventional banking. But banks are permitted to offer incentives such as variable bonuses
in cash or kind on these deposits.
Scope and challenges
Globalisation and the convergence of financial services mean that Indian banks will face an increasingly tough
competitive environment, but there is tremendous scope for banks, particularly Islamic banks, because India needs
major investment in its infrastructure. Islamic banking, however, has to be positioned as professional banking and not
religion-based banking, which can have serious political implications and as a result the Indian regulatory authorities
must be approached patiently and logically. The financial exclusion of a large segment of the population has farreaching implications for the socio-economic and educational uplift of the masses. These financially excluded classes
would not hesitate in sharing a return on their investment but they often find it difficult to meet the demand of a pre
determined return unrelated to the yield. If finance is available without the burden caused by pre-determined interest
rates, it will be a welcome development for the marginalized and also especially for same. Interest-free Islamic
Banking can fill up this gap. The collapse of leading Wall Street institutions, notably Lehman Brothers, and the
subsequent global financial tsunami and economic recession, Islamic banking is seriously being considered and has
emerged as a possible alternative to the conventional banking because of the followings:

It is based on Ethical and Socially Responsible Investments (SRI)

It aims at Equity and Justice and leads to poverty alleviation and

It acts to new dimension to assets and actual projects aiming to support real economic growth instead of
financial engineering.

It provides services to under banked populations ignored by conventional banks

Almost all the foreign banks have started their Islamic Banking units or divisions in their respective banks. In India, a
large amount of funds are lying in current accounts because of the reason of avoiding interest. In some localities,
certain communities are not banking because of their attitude towards interest. These funds can be taped into the
interest-free banking net work and the dividend or profit.
India is a secular country and anything attached to any particular community or religion may create problem to the
government. The challenges and critical issues involved are the varying interpretations of Islamic principles (Shariah)
across regions, countries and even within the same country is a big challenge. Shariah Council, an independent bankappointed panel of scholars determines the Islamic practice and its interpretation. Therefore, based on the
interpretation of what is considered Islamic in Malaysia maybe prohibited in India. This absence of uniform standards
might affect the banks ability to replicate and implement Islamic banks and products across geographies and expand
to other states. This council must approve all innovative products but, without a uniform interpretation, it becomes
very difficult. Another challenge is the regulatory framework governing these banks leading to operational problems
like there is no accounting, auditing, and credit analysis standards for Islamic banks till now. To operate in globalised
economy, RBI is looking to banks to meet international standards and Islamic business model might have a problem in
complying with it. Another major challenge is winning investors confidence. The conventional banks have the facility
of deposit insurance and credit guarantee which develops sense of security and confidence among investors, which is
not available for Islamic banks.
Advantages of implementing Islamic banking in India
Islamic banking can alleviate poverty bring down economic disparities as there is no interest commitment on the part
of the lender. It can inculcate the habit of saving among people and create the financial inclusion required in India.
Islamic banking draws finances from both Muslims and non-Muslims alike. Islamic banks offer financial instruments
that are profitable but also affordable and ethical. Islamic banks in the global scenario are the solution to economic
turndown. One of the important factor which resulted in international financial crisis are innovative financial products
and transactions and short selling (Short selling occurs when stock market participants sell stocks / commodities which
they do not own in order to profit later from an anticipated fall in prices). Islamic banks are insulated from interest
based transactions because Islam as a religion prohibits interest and also prohibits short selling.
There are a lot of benefits to India to open a full-fledged Islamic bank and encourage and allow Islamic banks to enter
the market place. The entry of the Islamic banks raises important questions about its potential impacts. On the one
hand, entry of Islamic banks is positive in terms of product innovations and financial inclusion and may encourage the
adoption of best practices among the incumbent banks. Islamic banks would be beneficial for all entrepreneurs who
have profitable proposals but lack collateral. On the other hand, competition from conventional banking system is

expected to intensify, necessitating the smaller Islamic banks to establish their positions. The interpretation of
fundamentals of Islamic financial principles and emergence of clear standard and a common framework will help bring
about improved management practices in Islamic banks resulting in higher growth and profit margins.
Failures of Islamic Banking
The reasons of the failure of Islamic banking in India are on account of both external and internal factors. Externally,
when the whole world finance is based on interest, it is extremely difficult if not impossible, to introduce Islamic
financial institutions on a limited scale. This is all the more so when the world markets are getting integrated. The
difficulty becomes greater when appreciate that the Muslim community itself does not seem to be convinced either
intellectually or on practical grounds about the interest being haram. The questions being raised about the difference
between interest and usury or between interest and bank interest on the ground that bank interest is not exploitative
are examples of this confusion. Add to this the point that in a world where it is practically impossible to completely
eschew interest based transactions and you come to a situation where the implementation of interest free banking is
fraught with impossibilities Among the internal reasons the most important are that Islamic banking is based on
ethical and moral principles and it is not possible to put the entire burden of Islamic banking on the lending
institutions. Borrowers` duties and responsibilities are not even discussed in discussions of Islamic banking. Then there
is the almost evident point that Islamic financial institutions are almost always run by those who believe in Islamic
principles and are well versed in Shariah but are not so well aware of rules of Islamic Banking, which are based on the
fundamental principle that confidence is the backbone of running a successful institution and confidence is a factor of
implementing well known canons of prudential banking by honest professionals. Many of the Islamic institutions have
come to grief because of the mismatch between demand liabilities and illiquid assets, Of course, part of the reason
was the absence of suitable invest opportunities, a point related to the competitive integrated markets.
Conclusion
There is no doubt that a huge potential for Islamic banking in India exists, but, it will need some strong policy
decisions to make it a reality. With a population of 156million Muslims India stands to gain tremendous advantages,
not least by attracting around $1trillionUS in Islamic investment funds from Gulf countries. This would help the
national current account and keep the fiscal deficit in check. At the same time it must be borne in mind that Islamic
banking can provide immense opportunities to energise the Indian economy with the participation of previously
excluded Muslims in Shari'ah-compliant banking and at the same time could lead to substantial inward investment to
boost India's further development. It would also help the poor and vulnerable, allowing small manufacturing, retail and
agricultural enterprises to access finance as well as providing equity funding for infrastructure projects such as
irrigation, dams, roads, electricity and communications projects, which are key to the development of the Indian
economy.