ISLAMIC FINANCE AND INDIA: A RESEARCHED REVIEW

AMP-ian Brother Fuzail Sait shares inputs on Islamic Finance and some good research on work done so far in India with us.

As part of my MBA Executive at Christ University in 2020 I completed a Research Project on Islamic Banking in India after doing a lot of literature review as well as my own research on the topic. This article is an a summarized excerpt.

Islam as a way of life and as a system provides ethical guidelines for human behavior throughout life. Islamic beliefs are the basis of this. The beliefs establish deeply the relationship between the individual and Allah (God), the individual and other individuals and also between the human being and his/her life’s environment.

Banking, Finance and Economics is one of the most significant aspects of human life. Humans spend a majority of their life-time in such activities. Economic conduct, as expressed in terms of economic activity necessitates the production, distribution and consumption of goods and services. As part of its guidelines towards the economic conduct of humans. Over the last few years, the world bore witness to a renaissance of Islamic Economics. Islamic Banking, Islamic Economics and Islamic Finance are not an uncommon nomenclature and school of thought at present. After the recent global financial crisis, this topic has been researched with a lot of attention by scholars and people on various subjects.

The basics of Islamic economics are deduced from two chief sources:

Quran

The first of the two origins Quran means ‘the recital’. Quran is the divine book of the Muslims across the world and they recite parts of it 5 times a day during their prayers. Therefore, the quran as a book that is meant to be recited and understood. It is the only literature that has been proved to have remained unchanged for over 1400 years. The purpose of the quran is therefore not just limited to recitation but to understand and implement the divine knowledge. It is the word of Allah (God), revealed as the final guidance for humanity.

The quran was revealed to Prophet Muhammed (Peace be upon him) Allah’s final prophet and messenger (they were many prophets before him including Moses, Jesus, David, et al in which the Muslims have to believe as well). The Quran contains 114 chapters containing more than 60,000 verses discussing various legal principles and injuctions dealing with every aspect and sphere of human life and existence such as rituals, marriage, divorce, succession, inheritance, promotion of peace, economics, commerce, etc. To establish an ethical and pure way of life.

Economics has been one of the most important topics in human history and given this importance for the benefit of the society at large, Allah has revealed in the quran more than 80 verses out of which one of the verses is the longest in the quran. These verses associate, directly and sometimes circuitously to the subject of economics, business and commerce.

Sunnat or Sunnah

As we have discussed the first source of Islamic economics, we can now move to the second most important source. The Sunnah – it refers to the customs and habits of the Prophet Mohammed (Peace be upon him) that include his sayings, activities and silent approvals. Prophet Muhammed (Peace be upon him) was the last messenger and the seal of all the prophets in the series of prophets and messengers sent by Allah (God) for the guidance of Humanity. He was the preserver and restorer of the monosthetic faith which Allah sent guidance to before him that included Prophets like Adam, Noah, Abraham, Moses and Jesus and all other prophets (peace be upon them all). The customs ascribed to the prophet Muhammed (peace be upon him) are known as hadith. Using biographic analysis, these hadith were accumulated and followed by different scholars over the years, among others, a body of six most reliable books known as Saha-e-Sittah.

The Fundamentals of Islamic Banking

1. Sharing of Profit or Loss and encouraging risk that is shared/distributed
2. Prohibition of investing in Illegitimate business and industries
3. Forbiddance of Riba or Interest or any other pre-arrangement over and above the principal amount.

 The IB Industry framework

It should be noted that the Islamic financial institutions and Banks take different forms across the world.

1 Full-fledged Islamic financial institutions like Islamic Bank Bangladesh Ltd and Meezan Bank in Pakistan.

2 Separate sharia-compliant business units in conventional financial institutions (for example: HSBC has HSBC Amanah)

3 Islamic subsidiaries of conventional financial institutions (for example: Citibank subsidiary Citi Islamic Investment Bank (Bahrain), Union Bank of Switzerland subsidiary Noriba Bank).

4 Islamic NBFCs regulated by Central Banks as in India.

The Sharia Consultants and Advisory Councils

Institutions that wish to offer Islamic Banking Products should establish a Shariah Supervisory Board or SSB (These are essentially a board of Sharia Scholars specializing in Islamic Commercial Jurisprudence). The board then advises them whether or not to go ahead with the respective finance and banking products and services after check if they are compliant with Shariah. They ensure that the banks activities are in line with the sharia principles.

The Islamic Banking Products

Islamic Banking has sharia compliant products and services that follow the guidelines of Islamic Law. Though there are many products few of the most important products are explained conceptually below.

Musharakah

It is profit and loss sharing arrangement or a participatory mode in Islamic Banking. It is a partnership or a joint venture in which all the parties involved contribute to finance a venture. Profits are shared by the parties based on a pre-agreed ratios while losses are shared on the basis of equity participation by the parties as Islam says one cannot lose what he did not contribute. Management of the venture can be either by all or by one partner.

Mudarabah

It is a contractual partnership for profit/loss sharing in which one person brings the capital (known as rabal-maal) and other the human skill needed to carry on the economic activity (known as mudarib). The profits will shar        ed on pre-agreed ratio; however losses will be borne only by the financier and hot by mudarib. The loss shall also be passed on to the depositors.

Murabah

It is a contract of sale between the Islamic banks and the clients. Under this contract the banks buy an asset on behalf of the client and then sell it to them for a price plus an agreed profit for the banks. It is also known as mark-up or cost-plus pricing. Repayment by the client is made in the form of installments. Murabah is most commonly financial operation used by the Islamic banks with which they earn their profits and are able to prohibit payments of interest according to Islamic Law.

Takaful

It is commonly referred to as Islamic Insurance. Takaful is based on the principle of cooperation and separation between operations of shareholders and the funds. Therefore, 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 policyholders 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.

Ijarah

It is a lease agreement between the Islamic bank and its client. The bank would buy an asset as per the client and allow the client to use the asset for a specified lease period and a lease fee. However, the ownership of the asset shall remain with the bank.

Qard Hasan

Islamic banks lend loans on the basis of goodwill. No interest or profit is charged on these loans. The borrower is required to pay only the amount she has borrowed. These loans do not charge the borrower the time value for the money and are consistent with the principle of prohibition of interest.

Halal activities

Banks prohibit investing in any sinful (haram) activities. It prohibits and abstains from business projects related to gambling, pork products, weapons, defense, alcohol, pornography and any speculative activates according to Shariah Law.

Sukuk

It is an Islamic equivalent bond. The investor of sukuk shall get a share of an aasset along with 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.

Wadiah

It is the acceptance of the sum of money for safe keeping which will be repaid. Bank is the keeper and trustee of funds and liable for safe keeping of funds and returning them on the demand of the customer. Banks at its discretion shall reward the customers (hibah) as an appreciation for keeping the funds with the banks.

Salam

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 of financing is often used in the agricultural sector in which banks advance the money for inputs without charging interest and in return shall get a part of produce which will be sold after its delivery.

Waqf

It refers to a voluntary dedication of one’s wealth and property for religious purposes. The waqf property can neither be sold nor inherited or donated to anyone but used for Shariah compliant projects.

THE BENEFITS OF INTRODUCTION OF ISLAMIC BANKING IN INDIA

To build the case for the need of Islamic banking in India we can firstly consider India’s economic growth and potential demographic dividend that is expected in the next two decades. Firstly, we should understand that it is the youth that will be driving this change and the youth of today are educated and professionals unlike their ancestors.

Islamic banking can also serve as a mechanism to overcome the country’s low capita income, liquidity and inflation problem by opening up money market that participates in business. Currently the Indian Banking Regulation act does not allow banks to participate in business but restricts the services only to lending money and receiving transactions based on interest.

Also, Muslims avail just 4% from NABARD & .48% Credits from SIDBI respectively. Introduction of Islamic banking therefore may act as a boost entrepreneurship development. However, it should be noted that Islamic Banks are not only profitable but they are also ethical and in the larger interest of the society. India could also after introduction benefit from the inflow of interest free funds from the GCC, it would also boost microfinance, promote profit and loss risk sharing and general business Jurisprudence, equity finance and low cost capital would be a new revolution in agriculture and transform the agricultural sector into a formal one and give financial empowerment to of majority of Indians. (Team YS, 2009).

Islamic banking will also create job opportunities in the education sector,

The Sachar committee report claims that the Indian Muslims have a share of 7.4% in saving deposits while only 4.7% in credits. Therefore, a large number of population or market requires Islamic Banking Services. There is also a potential to complement the conventional banks with more options and choices for existing banks in India and for them to appeal to a sector that cannot be ignored in the Indian Population – the Muslims.  It will mainly benefit the weaker sections of the economy which is critical for a large economy like India and reduce disparity in income. It has the potential to eradicate poverty through SME’s financing, rural and agricultural growth and their operational expansion. Provision to provide loans to businesses and to reduce the high inflation through less artificial money and less funding in speculative businesses. Also, according to a report by world bank the poor in India has gone up from 421 million in 1981 to 46 million in 2005.

 GROWTH & POTENTIAL

The potential for Islamic banking in India mainly lies in two points:

1. India could be a significant market in the global Islamic finance market owing to the large size of Indian Muslims.

2.It is still subject to regulatory changes and financial inclusion as per a report of International Journal of Marketing Financial Services.

There are many small financial institutions in India that already work in the Islamic way and 200 in Kerala Alone. And these do not restrict their lending to muslims alone. Another example is for another tier II city if India Bhatkal where an Islamic organization reduces the stress on the poor by providing interest free loans. Rather than charging interest it accepts Jewellery or gold as collateral.30% of these customers are non-muslim!  However, as the government is yet to recognize the organization as a bank it operates as a Society. India has the second largest number of Muslims in a given country as such introduction of Islamic Banking will aid to the development of Muslims and the lower classes of the society as well.

REGULATORY PERSPECTIVE

A Kerala High Court passed a landmark judgement in which it upheld the constitutional validity of Islamic Banks. Through in the light of the present regulations it is not feasible to establish such banks. Since Islamic Banks don’t deal in interest they work and function as investment companies. They are fundamentally different from conventional banks as they operate on the profit and loss structure which requires a client to invest with a client in order to finance their needs.  Returns are handed over basis the profits earned by the bank and risk sharing is a key component.

In India:

1. Sections 5(b)16 and 5(c)17 of the Banking Regulation Act 1949 prohibit any bank to invest in a profit & loss structure which is the very basis of Islamic banking,
   1. Section 818 of the Baking Regulation Act says that no banking company can directly or indirectly deal in buying goods or services or bartering of goods.
   1. Section 919 prohibits the bank to use any immovable property apart from private use this is against Ijarah home finance.

4. Section 2120 of Banking Regulation Act requires that an interest be paid, this is   against sharia.

Islamic banks cannot deal in interest and Banks in India have to maintain a deposit account with the RBI over which they get interest. This is essentially against the tenets of Islamic banking,

Two committees were set by the government in this regard: to study Islamic Banking:

1. Anand Sinha Committee

This committee presented a report that said that Islamic banking under the current legal framework is not possible and that many changes have to be made in the Banking Regulation Act. Apart from the conventional current account no other product could be modified to adopt Islamic banking.

• Raguram Rajan Committee

This report under the Sector Reforms under Dr. Raghuram Rajan seems to hold is possible to introduce ‘interest-free’ banking in India and submitted its report in 2008.

And Indian Banks Association report also made recommendations that changes would also have to be made to the taxation aspects as Islamic banks do not permit interest.

Factually Islamic banking would empower more that 90% of those in the unorganized sector of agriculture, manufacturing and retail industries in india.

Also, it is to be noted that Islamic banks in india do not function under the conventional banking regulations and as such have to be licensed as a the Non-Banking Finance Company.

Mainly again due to the non-indulgence in the P&L regulation cap on banks. The requirement of minimum level of net owned funds will be Rs. 2 crore. The Central Banks would now need to work out the proper framework to comply with RBI & SEBI rules.

3.4 CONVENTIONAL BANKING VS ISLAMIC BANKING

For a better understanding. The main differences between Conventional banking and Islamic banking are as follows:

Table 3.1 Comparison of Conventional Banking with Islamic Banking

Conventional	Islamic
1 Operates on the basis of conventional man-made principles.	The Functions and operates on the basis of Islamic regulations / Shariah
2 Main objectives to maximize profit without any restriction.	It aims at maximizing profit but subject to Shariah restrictions.
3 It can charge penalty and compound interest in case there is a default	No interest is charged. Only a small compensation is charged which is also given to charity.
4 Lending money and getting back interest is fundamental function	Partnership is business is fundamental function
5 Investor is assured and get a predetermined rate of interest	There is no pre-determination of anything, It promotes sharing of risk between investor and entrepreneur.
6. Low importance is given to developing project appraisal and evaluation	Since the profit is shared it gives greater attention to business aspect of project evaluation and appraisal.
7. The relationship between bank and client is that of creditor and debtor.	The status of relationship between bank and client is that of partners, investor, trader, buyer and seller and nothing else.
8 It is concerned with the elimination of risk in any transaction	It is concerned with the risk bearing in any transaction
9 It does not deal with Zakat or (simple Islamic tax)	Banks also function as Zakat collectors on behalf of clients and also pay their zakat.
10 When entering a transaction with consumer they focus only on the benefit from the consumer in interest and not take liability of the consumer.	They bear all liability in transactions and getting any benefit without bearing liability is declared Haram. Also, no interest in any transaction.

CONSTRAINTS IN INTRODUCTION OF ISLAMIC BANKING IN INDIA

1. Products are Interest Based: A bank that gets licensed by the RBI becomes a part of the financial system in India and creates money through deposit generation and acceptance. Basis the principals of interest restrictions in Sharia Islamic banks cannot operate.
2. No power to issue Cheques: They cannot function as banks unless powers of issuing cheques is given to them. It is mandatory also for banks in India to keep fractional cash reserve with RBI and statutory liquid assets. Thus, they have to keep an account with RBI and get interest, as this is interest based, Islamic bank cannot hold them. 
3. Capital Adequacy: If maintenance of capital adequacy is not met by Islamic Banks they would be unable to work with the interest based banks and money market.
4. Lack of ability to evaluate projects: Islamic banks concentrates onshort and medium term operations and the lack of ability to evaluate long term projects for needs of a country due to the smallness in their operations.
5. Legal Framework: The present legal framework does not allow Islamic banks to function within the shariah which is the core of the Islamic Banking business. And it cannot use any other banking product other than the current account which can be modified for use by Islamic Banks.
6. Taxation Issues: Interest and profit are treated differently. And so the absence of interest in Islamic Banking transactions is something that the tax authorities are yet to incorporate in the taxation procedures and guidelines governing the country like IndAS.
7. Legal tricks through unscrupulous sources: This is something that the Islamic banks are currently dealing with. How does an Islamic bank overcome such anti-social defamation which play around to overcome sharia restrictions is yet to be solved.

BENEFITS OF ISLAMIC BANKING

Islamic Banking when successfully introduced in India will provide lots of benefits to the Muslim Community and the country at large namely;

1. Inclusive Economic Growth: It will benefit not only the Indian Muslim community but also the fellow countrymen and help eradicating poverty by removing income disparity and reducing risk of interest on early borrowers of funds.The Muslim community will become more involved in the financial sector if they get shariah compliant products and services.

2. Increase in Beneficial FDI without interest in debt: The introduction of Islamic banking will open up the renowned business houses of the GCC countries motivating investors and beneficiaries

3. Business Funds availability: Under the Ijarah product format (lease-cum purchase) shariah compliant equity microfinance will benefit purchases by way of tools equipment etc. and the Murabahah (cost plus) can be used to provide funds for trading and material purchases for manufacturers.

4. Removing Exploitation: If a welfare state needs to be set up then there is a need for Islamic banks as per renowned scholar and senior advisor Dr. Mohammed Umar Chapra.  People would be saved from exploitation and their basic needs could also be met.

PRESENT STATUS IN INDIA

As of today, there are many Baitul Mals (charity and social welfare centers) working in Indian villages and cities. They operate specifically and a very microlocal level and as such there has been no consolidation. They are only about 10 to 15 proper operational Islamic banks which have deposits of about Rs. 75 crores or around that figure. In the regulatory framework they are not registered as Islamic banks but are registered as NBFCs or Non- Banking Financial Companies which are registered as per Non-Banking Finance Companies Reserve Bank Directives 1997 RBI (Amendment) Act 1997.  They are operating across the country and various states. In India the Islamic banks provide home loans on the basis of co-ownership, Mudarabah as well as on Musharaka basis. Some banks also finance transports on the mark up basis via hire purchase and education and skill finance is also provided by them.  The investments in shariah compliant shares are also done. There also exists the Shariah Index in the BSE and a few Shariah Approved Mutual Funds like the Tata Ethical Fund. There are also Islamic wealth management and invest companies like Pragmatic Wealth Management. India also has associations which promote the cause of shariah in all aspects of professional life and this is called Association of Muslim Professionals which operates globally. They also have associations like Muslim Industrialists Association and the Muslim personal Law Board. India also has the Students Islamic Organization of India, Institute of Islamic Banking & Finance of India, Islamic Research and Educational Foundation, Indian Islamic Finance Center. However, all these do not operate centrally and are operational at a localized level as there is no Ministry which manages India’s Islamic affairs. However, in order to start Islamic Banking in India the government should take initiatives to understand the Islamic Banking Framework globally and work closely with other well-established Islamic banks globally and conventional Indian banks which would like to introduce Islamic banking products before actually introduction these products. They could also regulate Islamic banks the same way Foreign banks are regulated in India.