Application of Islamic Banking

As u wud know Islamic banking means banking which is consistent with Shariah. Sharia prohibits the payment or acceptance of specific interest or fees for loans of money. The working of islamic bank is different from normal banks in the sense that they dont book interest income in their books. In India, however most of the banks are foreign entities and our regulator has not made policies which are favouring these banks. Although first islamic bank is setting up its business in Cochin> I would here qoute an article which I read a while ago

India being one of the countries which has not accepted the law relating to Islamic Banking is now introducing proposition for establishing the first ever Islamic bank in Cochin, Kerala.

However, a year ago, the RBI was asked by the government to look into the matter. The members of the committee submitted their recommendations few months ago, but the regulator, perhaps held back by obvious sensitivities, has not yet put the findings in public domain.

While the final form of report is not known, sources said the members have pointed out how Indian banking laws come in the way of various Islamic banking principles.

These are as follows: Al Wadiah (for Saving Bank Account):

• Section 21 of the Banking Regulation Act requires payment of interest on such deposits; thus, interest-free deposit and simple charging of premium or Hiba is not permissible.
• Mudarabah (for term deposit or investment): Here again, Section 21 of the BR Act disallows such products where the bank can invest the money in equity funds (in India, equity exposure is determined by a separate set of rules), and the client has complete freedom in the management.
• Mudarabah, Musharakah (for project finance and SME credit): Sections 5, 6 of the BR Act indicate the forms of business a banking company can undertake and does not allow any kind of profit-sharing and partnership contract, the basis of Islamic Banking.
• Ijirar (for home finance) : as against Islamic Banking where the banks owns the asset and hold the title, Section 9 of the BR Act prevents the bank from any sort of immovable property other than private use.
• Istisna (leasing, buyback): Besides the usual curbs on acquiring immovable property offering Islamic banking products many not be bankable due to stamp duty, central sales tax and state tax laws that will apply depending on the nature of the transfer. In the markets like the UK there is separate law that makes it possible to launch Islamic banking products. The BR Act even disallows an Indian bank from floating a subsidiary abroad to launch such products, or offering these through a special window. Thus, the upshot of the findings is that such banking experiment is impossible without a new law and multiple amendments to the BR Act thereof.

Though the RBI study group had earlier rejected the concept of Islamic banking it was given a green signal by the Raghuram Rajan Committee on banking reforms. A report prepared by Ernst and Young was approved by the Kerala industries on August 12, 2009. Its likely that the registration formalities will be completed and the bank will be operational in 2010. Kerala State Industrial Development Corporation, which is the designated agency for the formation of the bank, will have 11% stake in the proposed banking company. According to the government officials it will be registered as a non banking finance company in the beginning and later get transformed into a full fledged Shariah-Compaliant bank. However the biggest challenge before the Kerala-based bank will be the formation of a Shariah Supervisory Board, including independent scholars on Shariah and banking business, in order to monitor the activities of the bank.

The islamically based system of finance has proven itself to be entirely feasible and sound. There are many benefits to the development of full-fledged Islamic banks in India which include a potential bettering of the condition of India’s largest minority and better integration of that minority into secular-democratic India. This would also enhance savings across the country and an increase in the national GDP growth rate. Reform, by opening to Islamic banks would be beneficial for all entrepreneurs who have profitable proposals but lack collateral. Increased political involvement, decreased inequality, business ownership and wealth will all serve towards the growth of our economy. All Indians will benefit from the increase in the GDP, the decrease in welfare expenditure, an increase in tax revenues, creation of new savings, employment opportunities and mobilization of savings. The increased growth would be the outcome of efficient investment allocation provided by Islamic banks.