Islamic Banking

September 3, 2006

Islamic banking in India: long way to go

Filed under: India, Articles & Commentaries

By Minna Kumar

Islamic banking as a concept has gained momentum world over and in India over the past few years. Several foreign banks operating in India, like Citibank, Standard Chartered Bank, HBSC are operating interest free windows in several West Asian countries, Europe and USA. There is also a growing awareness about the concept among Indian banks and it is generally felt that there is a huge potential market in India for Islamic banking products.

Islamic banking as a concept has gained momentum world over and in India over the past few years. Several foreign banks operating in India, like Citibank, Standard Chartered Bank, HBSC are operating interest free windows in several West Asian countries, Europe and USA. There is also a growing awareness about the concept among Indian banks and it is generally felt that there is a huge potential market in India for Islamic banking products.

Several banks in the country have shown an inclination to undertake this form of interest-free banking. However, unless proper regulations are in place to oversee this form of banking, it will not be possible for scheduled commercial banks to follow the Islamic rules of banking even in a small way.

This has led the Reserve Bank of India to set up a committee headed by Mr Anand Sinha, chief general Manager in-charge, department of banking operations & development to look into the matter. Islamic organisations like Jamat-e-Islami are taking an active interest in seeing it through; and its Maharashtra chapter recently organised a seminar of Islamic scholars and former bankers on this theme.

TimesofMoney has made a beginning in a small way by offering products & services that are in compliance with Shariat (Islamic Law) in alliance with Mashreq Bank, UAE. But this facility is strictly for remittances from the Gulf to India.

Presently in India, Islamic banking is confined to the co-operative sector. Only 10-15 Islamic banks with deposits of about Rs 75 cr are operating all over the country in various states. They are actually non-banking finance companies (NBFCs), which work on no-profits-no-loss basis. Islamic banks by and large cater to the needs of local area except a few that operate across districts or states. Their sources of funds are limited and as a result these banks have to operate on small scale missing the economies of scale.

Islamic banks in India provide housing loan, on the basis of co-ownership, venture finance on Mudarabah basis as well as on Musharaka basis and consumers loans. {Ref to Previous Article….} . Some banks finance purchase of automobiles on a hire-purchase basis. Education finance and skill development finance is also provided by them. Investments are made in government securities, small savings schemes or units of mutual funds. These banks also invest in shares of companies. Hire-purchase and lease finance are other source of investments.

These banks do not function under banking regulations. They are licensed under Non Banking Finance Companies Reserve Bank Directives 1997 RBI (Amendment) Act 1997. RBI has also introduced a compulsory registration system. Within the present system, even if banks are allowed to set up windows offering this service, they maintain cash reserve and SLR since these involve interest. This type of banking cannot avail facility of settlement and clearing system and therefore they cannot issue cheques. Other constraints are inability to maintain capital adequacy and would be unable to interact with interest based banks and money market in India.

Consequently, RBI cannot act as the lender of last resort because such accommodation by the monetary authority is also interest based. Islamic banks cannot interact with conventional banks based on principles of interest.

Islamic banking concentrates more on short-term and medium-term operations because long-term lending involves project appraisals and assessing long term profitability. Most such banks are ill equipped to handle this responsibility because of the smallness of their operations.

Regulatory issues need to be sorted out before Islamic banking can be introduced in India and its benefits can be enjoyed to the fullest.

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Islamic banking: Concept gaining momentum

Filed under: India, Articles & Commentaries

By Minna Kumar

Islamic banking is a very young concept. Yet it has already been widely implemented in the Islamic world and in a few non-Muslim countries as well.

The shariat or Islamic principles frowns on interest, but money can be lent on `reasonable terms.’ Several Islamic nations have embraced this form of banking and the banks are not essentially owned or controlled by Muslims. So, instead of lending and charging interest, what banks do is to buy the asset and lease it or hire it. What the bank earns is not interest but profit. Therefore the accounting systems also differ drastically from conventional banking.

Even Islamic banking understands that banks cannot do charity. They have to earn their reward for the services rendered.

Investment finance is offered by these banks through ‘Musharka,’ where a bank participates as a joint venture partner in a project and shares the profits and losses. Investment finance is also offered through ‘Mudabha,’ where the banks contribute the finance and the client provides expertise, management and labour and the profits are shared in a prearranged proportion, while the loss is borne by the bank.

Mudaraba participatory financing is a unique service offered by Islamic banks. This system can offer responsible financing to socially and economically relevant development projects.

These banks also offer trade finance in a number of ways. One way is through mark-up, where the bank buys an item for a client and the client agrees to repay the bank the amount along with an agreed profit later on. Banks also finance on lines similar to leasing, hire purchase and sell and buy-back. Consumer lending is without any interest, but the banks cover expenses by levying a service charge. Besides, these banks offer a host of fee-based products like money transfer, bill collections and foreign exchange trading where the banks own money is not involved.

Apart from being widespread in Islamic countries, this practices is also followed in several countries in Europe and the Americas. In India, though there is no full-fledged Islamic bank, there are many non-bank financial intermediaries operating on Islamic principles. Several co-operatives throughout the country also operate on these principles. The Reserve Bank of India has recently appointed a committee to look into the prospects of introducing certain Islamic products in Indian banks.

There are several drawbacks to this system. In many countries, Islamic banks do not have the power to issue cheques. Internal controls need to be devised in countries where these banks do not operate on the large scale. Inadequacy of information about this system and lack of regulations specific to Islamic banking can be a deterrent for these banks to co-exist with other banks.

These irritants, though minor, need to be ironed out before this unique system can find complete adaptability in non-Islamic parts of the world.

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