Islamic Banking and Finance in India: Opportunities and Challenges

Islamic Banking and Finance in India:
Opportunities and Challenges

Manzoor K.P1
Abstract
The current economic policies in many countries have been questioned by eminent economists
and policy makers since worldwide economic down turn. The Muslim economists strongly
believe that the global financial crisis is resulted from mismanagement of monetary policy and
banks higher interest rate policy by the lack of socio economic objectives. Therefore, many
secular nations find the Shariah banking system is an alternative economic mechanism for
bringing economic stability in their nations. In India too, we have started many discussions
for Islamic bank in the nation due to bad performance of our economy during the crisis
period. The eminent economists in India suggest that Islamic bank can play a greater role in
her fast moving to become an economic super power in the world. In India, Muslim
population constitutes 13.4% of total population of the country and most of them keep far
distance from countrys financial activities due to high domination of interest in our
economy. Government and RBI appointed different committees to study the grasping
opportunities for Islamic banking in India. But all committee advised them that opening up of
Islamic baking are impossible in our current banking regulation Act of 1949. In this case, the
global Islamic banking industry has to remove all its barriers to extend its operation in all
over India.
Keywords: Financial Crisis, Islamic Bank, Modaarbah, Shariah, NBFI, Islamic

Economics, Halal, RBI
Introduction
The world wide economic down turn commenced by the failure of sub mortgage
system in the US stimulates the process for Islamic banking system in many secular
nations. Muslim nations were only the subscriber of Islamic banks in the initial stage
of 21st century.. But, the worst experience of crisis forced the well known secularist
nations like UK, Singapore, Japan and Honkong to change their banking laws for
smooth operation of Islamic banks in their nations. Consequently, many international
banks and non banking financial institutions opened new windows of shariah bank in
1
Lecturer in Economics, Irshadiya College, Calicut; Kerala
108 Journal of Islamic Economics, Banking and Finance, Vol. 9 No. 1, Jan - Mar 2013
western nations. The terrific international banks such as HSBC, Standard Chartered
and Citi Bank take the great effort to promote the Islamic financial system in these
nations. Globally, many banks have been shut down their operation due to the
harmful effects of financial meltdown. The Islamic economists argue that impervious
interest rate and monetary policy create a huge pressure on normal economy. The
normal economy offers the rent for use of land, interest for use of capital and profit is
reward to entrepreneurs. The basic cause of the financial crisis lay in the nature of
economy in which the erroneous monetary policy and high interest rate system leads
the most of borrowers to impoverishment. Mostly, the borrowers fail in repaying the
loan because the high interest rate always makes a heavy burden on their shoulder.
However, when borrowers default in repaying the loan it creates liquidity crunch in
the economy. The current financial crisis is considered to be the most damaged crisis
after the great depression in 1930s. We had found the final solution for the long term
great depression by the publication of Keynes major work The General theory of
employment, interest and money in 1936. At that time, the eminent economists and
policy makers completely ignored the neo-classical economic theory and accepted the
major policies and recommendations of Keynes to escape from the evil effects of
great depression which showed its positive result in early 1940s. Keynes sharp
macro economic tools such as Principle of effective demand, Liquidity preference
theory of interest and psychological law of consumption had given the mega relief
to the capitalist nations to encourage their economy during the depression period.
Where as, the Islamic economists strongly believe that the current global financial
crisis is resulted from the mismanagement of monetary policy and banks higher
interest rate policy by the lack of socio-economic objectives. Although, the global
financial crisis adversely affected the capitalistic and other powerful economies, the
major victims of the crisis are considered to be the people of developing and under
developing nations. The Muslim economists argue that non interest banking system
can only rescue the global economy from the current scenario. These people strongly
advocate for Islamic banking and finance (IBF) for the smooth functioning of the
global economy. However, an Islamic bank working on Islamic laws (sharia)
provides the loans to investors and accepts the deposits from public on non interest
basis. In the Islamic banking system, the investment of capital is on partnership with
the bank and entrepreneur (modaarbah). At least, two members are required for
smooth operation of modaarbah system in an Islamic bank. Sometime, the members
may be more than two. Prior to begin the investment, the bank and investor make an
agreement on the share of profit which must acceptable for both parties. The principle
of modaarbah also states that banks and entrepreneurs are liable to bear the losses
too. The concept of Islamic banking has been working on the principles of Islamic
law which introduced during the second half of the twentieth century. But the Islamic
Islamic Banking and Finance in India: Opportunities and Challenges
109
banking system commercialized in 1970s with the formation of Islamic development

Bank (IDB) based in Jeddah, Saudi Arabia. The prime objectives of the Islamic banks
are to bring social, economic and political justice in all aspects of human life. At the
same time, theres certain principles that must follow by an Islamic bank are i)
prohibition of interest (riba) ii) risky transaction must share by both parties (ie, banks
and investors) iii) Islamic financial system strongly eliminates the speculative
transactions (Gharar). The Islamic development bank (IDB) reports that Islamic
banking and finance (IBF) shows 10 -15% annual growth in both Muslim and non
Muslim nations. Globally, the total worth of Islamic banks considered to be the more
than 300 billion dollars. Further, the Analysts of International Islamic Finance Forum
forecast that global asset of the Islamic bank will reach to $4 trillion by 2020.Infact, if
we are successful in establishing Islamic banking and finance around the global
economy; we can make a strong international monetary system in the world.
The objectives of this paper are
i) To study and analyze the scope and opportunities for Islamic banking and
finance in India
ii) To understand the challenges for Islamic banking and finance in India
iii) To compare conventional and Islamic economic system
In India, the Banking Regulation Act of 1949 distinguishes the financial institutions
as i) Banks and ii) Non Banking Financial Intermediaries (NBFIs). Further, the banks
can be divided in to a) Nationalized Banks b) Private Banks c) Foreign Banks and d)
Co-Operative Banks by the various Acts. (Banking Regulation Act 1949, Researve
Bank of India Act 1934, Negotiable Instruments Act 1881 and Co-Operative Societies
Act 1961 etc.). When our conventional banking laws showed deep favor to banking
with interest system, the operation of banking without interest extensively
prohibited in the nation by exhaustive banking regulation Acts. But, all these banking
Acts do not inhibit the operation of Islamic finance completely in India. Moreover,
our prudent banking laws permit the Islamic finance to workout their operation as
Non Banking financial intermediaries (NBFIs) in the country under the direct
supervision and control of Reserve Bank of India (RBI). The Non- banking financial
intermediaries are the financial institutions other than the commercial banks and
cooperative banks participating in the process of financial intermediation.
Comparatively, the functions and operational freedom for NBFIs are very limited in
the country. The liabilities of the NBFIs are not accepted as a medium of exchange
and NBFIs do not have the power of multiple credit creation. Besides, the total
volume of credit offered by the NBFIs cannot exceed the saving collected by them.
The NBFIs can accept deposit from the public for a maximum period of 36 months.
These constraints may be the big factors for the slow growth of Islamic banking and
finance in India. But, the recent crisis widely discusses the importance of banking
without interest in the country, in which the crisis seriously injured the major sectors
of our economy. Since July (until December 2008) FIIs have pulled out 12.5 billion
dollars and the rupee has depreciated by 20 percent. External commercial borrowings
which are used by the corporate sector have dried up and so have suppliers credit.
This contraction produced a liquidity crisis in the system. The drying up financing in
external markets for Indian banks and corporate houses, difficulty in raising finance
in bearish capital markets and lower internal accruals for corporate houses, meant
greater pressure in the Indian credit markets. The reversal of capital flows has put
pressure on the forex market. Real GDP growth rate has moderated in the first half of
2008-09. Therefore, the Islamic economists argue that if we could make the huge
presence of Islamic banking and finance (banking with no interest) in the country, the
economy can survive the crisis very quickly. Besides, the concept of Islamic banking
can promote a relief from the economic slavery and it helps the country to follow a
democratic banking system.
Table: 1 (Countries with largest projected increase of Muslims)

Country
Estimated
Muslim
Population(in
Millions)
Projected
Muslim
population(in
Millions)
Projected
numerical
increase(million)
2010
2030
2010-2030
Pakistan*
178.08
256.11
India
177.28
236.18
Bangladesh*
148.60
187.5
Indonesia*
204.84
238.83
Afghanistan*
29.04
50.52
Iran*
74.81
89.62
Turkey*
74.66
89.12
China
23.30
29.94
Uzbekistan*
26.83
32.76
Malaysia *
17.13
22.75
(*Muslim Majority Nations) Source: Pew Forum (2011)
78.02
58.89
38.89
33.98
21.48
14.8
14.46
6.64
5.92
5.61
111
The growth of Islamic banking and finance is very slow in India. As the worlds third
largest Muslim populated country after Indonesia and Pakistan, Islamic banking and
finance has number of opportunities in the country. In India, the total strength of
Muslim population was 177.28 million in 2010(see table 1).It constitutes the 13.4%
of over all population of the country. International demographic experts have foreseen
the countrys Muslim population will cross 236 million by 2030. India is the first non
Muslim nation which reports the highest growth in Muslim population and placed
second after Pakistan in fastest growing Muslim populated nation in the world. It
encourages the Muslim economists arguing for Islamic banking and finance in the
country. However, the holy book Quran which is the source of every Islamic
principles divide the income earn by a person in two ways; a) Halal income and b)
Haram income. The Halal income is the moral income earn through the economic
activities permitted by Islamic laws (Shariah).While the halal income is never
acceptable for Muslim community because, this kind of income earn from the
restricted activities like prostitution, liquor, interest, gambling etc. In India, it has
large scope for Islamic banking and finance in which the majority of Muslim
population of the country desires to earn and manage their income or wealth through
halal ways. The halal income is the income other than from the restricted activities.
Therefore, the large volume of Muslim population keeps a far distance from the
countrys financial and economic activities. The high domination of interest on our
economy will be the absolute reason for the absence of Muslim community from
Indias financial sector. In 2005, Reserve Bank of India (RBI) appointed a committee
headed by Anand Sinha to study the grasping opportunities for Islamic banks in the
country. Unfortunately, the committee tabled the report with the conclusion Islamic
banking cannot operate in the country by current banking rules and regulation.
Raghuram Rajan committee report (April 2008) on financial sector reforms had
suggested the interest-free banking system for empowering our economy. In his
recent visit to Malaysia, Prime Minister Dr. Manmohan Singh asked the RBI to study
the prospects for Islamic banking gives a new hope again for Muslim community in
the country. Recently, the Bombay Stock exchange (BSE) has introduced a shariah
basis index named by BSE Thasis Shariah 50 for Muslim investors prove that
countrys financial sector dispel its untouchablity to Islamic finance. The BSE started
this index with the cooperation of Taqva Advisory and Sharia investment solution.
BSE Shariah Thasis 50 excludes certain firms like liqure, banks and non financial
institutes those who promote interest etc. which are restricted by Islamic law
(shariah). Many corporate and Asset Management Company of the country has been
showing their flavor to Islamic finance industry since last few years. The countrys
major corporate giant Tata has launched Islamic finance equity by the name of Tata
Indian Shariah Equity Fund (TISEF) in October 2010.While his counterpart Reliance
Anil Dhirubhai Ambani Group had opened an Islamic Asset Management Company
at Malaysia in 2009. State Bank of India (SBI) is countrys largest nationalized bank
showed its positive sign to Islamic finance and circulated a whitepaper on Islamic
finance inviting comments from the public on wheather RBI proceeds Islamic
banking in the country.
Significance of Islamic Banking and Financial Systems on Indias

Emerging Economy
The economy had suffered a long period of stagnation under the two centuries of
British rule in India. After the independence this long spell of stagnations was broken.
In India, the economic development has ushered with the introduction of economic
planning in 1950s. The improvements that are taking place in the economy are
permanent and structural in nature. These improvements can be seen in the output,
productive capacity, and institutional set up of the country. But, the long years of
colonial rule has been raised many issues of development such as poverty, inequality
and unemployment in our emerging economy. In most cases, our current economic
policies and financial systems are entirely failure to eliminate these social evils.
Instead of this, the Islamic banking and finance can play an inevitable role for
removing such social evils from the society by supplying the interest- free loans (alqard al-hasan) to different sectors of the economy.
Financial Inclusion on Agriculture:

Agriculture being the largest sector of the economic activity of India has a
crucial role to play in the countrys economic development by providing the
food and raw materials, employment to very large proportion of population,
capital for its own development and surpluses for national economic
development. One of the essentials of agricultural production is finance. In
1950s, the major source of agricultural finance of the country was from noninstitutional sources which consist of money lenders, traders, land lords etc.
113
Decadal Average Share of Institutions in Direct

Agricultural Credit (Disbursements)
Table: 2
Year
Cooperatives (%)
RRBs (%)
1970s
79.05
2.3
1980s
55.9
5.3
1990s
51.5
6.2
2001-02s
44.0
11.0
Source: Handbook of Statistics on Indian Economy: 2002-03
http://www.rakeshmohan.com/docs/AgricreditBulletin.pdf
Commercial
banks (%)
21.0
38.9
42.03
45.0
The share of non-institutional source of agricultural credit was 90% in the same year.
The farmers were highly exploited by the money lenders and other non-institutional
credit sources by charging the higher interest rate on loans provided for farmers in the
country. It caused the spread of debt trap among the poor farmers. In India, the
agricultural credit facilities more improved with the introduction of Green
Revolution in agricultural sector during the second five year plan (1960-65).
Consequently, the Co-Operative Credit Societies and other institutional sources
flowed large volumes of credit for farmers at cheap interest rate (see Table 2). In due
course, the Co-Operative banks and commercial banks reduced the volume of loans
supplied to farmers due to the fall in price of agricultural products. The increasing
agricultural expenditure and high lending rates of the banks create borrowings very
costly for farmers, while the returns are very low due to the fall in price of
agricultural outputs, which again led them to a massive debt trap. Every farmer is
burdened by debt in the country. Consequently, many mass farmers suicide cases
have been reported from the different parts of the country since last few years due to
the indebtedness. Islamic agricultural finance is only the radical solution for reducing
the ascended rate of mass farmer suicides in India. The Islamic agriculture finance is
completely an interest- free finance for farmers which not only protecting the poor
farmers from the exploitative hands of money lenders and other conventional
financial system, but also raises some confidence and secureness for them. There are
so many Islamic financial products are available for the financial assistance of
farmers which is still not touched in our agricultural fields. The Islamic agricultural
finance promotes the short term, medium and long term interest- free finance for
satisfying the financial requirements of the farmers. Bai Salam is one of the
effective and result oriented Islamic financial product for finding the solution of
farmers liquidity problems. By this product, the farmer sign on an agreement with
buyer for transfer of specified quantity of agricultural output at fixed price in future.
On this basis, the buyer issues an interest free loan in advance for the farmers. Bai
Murabahah and Musharaka are the short term Islamic agricultural finance
designed for small farmers to purchase the seeds, fertilizers and pesticides. While
Ijarah and diminishing Musharaka are designed as long term Islamic finance for
large farmers to purchase agricultural machinery, tractors and constructing farm
buildings etc. The lack of production and productivity are being now the greatest
problems in our agricultural fields. The Ministry of Agriculture evaluates that we can
increase the scale of production and returns by providing the adequate rural
infrastructural facilities like road, dams and power etc. The various products of
sukuk Islamic bond like Masaqa Sukuk will help the country to acquire the fund
for rural infrastructure, especially for irrigation. Unfortunately, our present financial
system for the farmers is not free from interest and apparently, it would be the actual
cause for indebtedness of farmers and low productivity of agriculture in India.
Financial Inclusion on Industry:
Economic development of India is impossible without rapid industrialization of the

country. As a second largest population country in the world, India faces huge
unemployment problem and subsequently, a large percentage of population are living
under the poverty. Therefore, the creation of new industries and expansion of old
ones will increase the volume of employment opportunities in the country. But,
industrialists are facing a serious financial problem due to the lack of available credit.
The industrialists require vast financial input for the promotion of industrial and trade
activities in our national economy. Unfortunately, the supply of capital totters in the
country due to the large withdrawal of deposited money from banks for investing in
other investment options (real estate, gold etc.) already created a serious liquidity
crunch in our conventional economy. Moreover, the large outflow of foreign
institutional investments (FIIs) from Indian equity market during global financial
crisis dispelled the dream of each industrialist for major source of industrial finance.
RBIs ineffective monetary policy is another important reason for dwindle of major
industrial finance source in India. To control hyper inflation and correct the prices,
RBI frequently hikes the rate of interest which makes borrowing very expensive to
the industrialists (see table 3). The expensive nature of credit and poor infrastructural
facilities forced the industrialists to rethink to stop taking part in Indias business
activities. In Islamic banking system, borrowers need not pay interest to the bank
while the bank charge a predetermined amount from the profit of investors. There are
so many Islamic financial instruments like Sukuk, Akad Murabha, Takaful,
Retakaful, Islamic capital market etc for accumulating the capital for investors from
an Islamic economy. Sukuk is an Islamic bond use by financial institutions to raise
the cash. The banks and other financial institutions issue the trust certificate to
indicate the share of investors. Islamic financial institution can allocate more funds
effectively for the growth of small and medium enterprise (SME) sector.
115
Table: 3 Data on Interest Rates

BANKS
PLR(%)
BASE RATE(%)
Mar
Apr
Jul
Aug
Sep
Oct
Nov
Dec
Jan
Feb
2011
2011
2010
2010
2010
2010
2010
2010
2011
2011 2011 2011
12.75
13.25
7.50
7.50
7.50
7.60
7.60
8.00
8.00
8.25 8.25 8.50
Punjab National Bank 12.50
12.50
8.00
8.00
8.00
8.50
8.50
9.00
9.00
9.50 9.50 9.50
Canara Bank
13.75
13.75
8.00
8.00
8.00
8.50
8.50
9.00
9.00
9.50 9.50 9.50
Bank of Baroda
13.75
13.75
8.00
8.00
8.00
8.50
8.50
9.00
9.00
9.50 9.50 9.50
Bank of India
13.50
13.50
8.00
8.00
8.00
8.50
8.50
9.00
9.00
9.50 9.50 9.50
Union bank of India
13.75
13.75
8.00
8.00
8.00
8.50
8.50
9.00
9.00
9.50 9.50 9.50
Indian overseas bank
13.75
13.00
8.25
8.25
8.25
8.50
8.50
8.50
8.50
9.50 9.50 9.50
Corporation Bank
13.60
13.60
7.75
7.75
7.75
7.75
8.25
8.25
8.90
9.40 9.40 9.40
Dena Bank
14.50
14.00
8.25
8.25
8.25
8.25
8.45
8.45
8.95
9.45 9.45 9.45
Icici Bank
16.50
16.50
7.50
7.50
7.50
7.75
7.75
8.25
8.25
8.75 8.75 8.75
Axis Bank
16.50
16.50
7.50
7.50
7.50
7.75
7.75
8.00
8.25
8.75 8.75 9.00
HDFC Bank
17.25
17.25
7.25
7.25
7.50
7.70
7.50
7.75
7.75
8.20 8.70 8.70
Weighted Rate
14.00
14.07
7.82
7.85
7.85
8.14
8.16
8.58
8.63
9.05 9.12 9.17
State bank of India
Mar April
Source: FICCI indiagovernance.gov.in/download.php?filename.../indianeconomy...
Islamic finance for infrastructure development

Infrastructure is a social capital that is embodied in such forms as help direct product
activities in the economy. The term infrastructure includes transport, communication,
energy and other public services like water supply which is essential for increasing
the qualities of the population in a country. Installation of more infrastructural
facilities will help a country to promote general economic activities rather than
producing commodities directly. Therefore, the very working of the economy is
determined by the infrastructural facilities. Unfortunately, India has very poor
infrastructural facilities that make a biggest constraint for her rapid economic growth.
India and China are competing each to be an economic super power in the world.
Compared to India, Chinas infrastructure growth is very impressive (see graph 1).
Therefore, Indian infrastructure report strongly advice the proper planning in
countrys infrastructure especially in power, transport and IT sector. Our policy
makers have given large priority for countrys infrastructural development in the
eleventh five year plan. The country needs huge capital for infrastructural
development, but the government has fund constraint in providing more infrastructure
facilities in the country. On the other hand, capital accumulation through the private
participation will never accept by few political parties in India. Although, many
infrastructure finance companies are operating in India, none of them are effective in
finding adequate fund for infrastructure development in our country. Instead of this,
many economists suggest the Islamic banking and finance can do their best for
accumulating necessary fund for infrastructure development . These people argue
that Islamic banking and finance can inflow large fund from Middle East and other
Muslim countries. The Muslim nations have invested their major portion of wealth in
USA and European countries which force them to withdraw the investment from
these nations due to the large effect of 9/11 and global financial crisis. Now, they are
searching suitable place for investing billion dollars in a trusted nation. Few States
such as Kerala, Bihar and Maharashtra are taking great efforts for Islamic banking to
accumulate the large capital for infrastructural development in their regions. The
Kerala government already completed the final process for an Islamic bank with the
strong participation of Kerala Financial Corporation, but invited enormous criticisms
from many parts of the country. Finance ministry of Kerala designed a plan to
accumulate at least RS 10,000 crore through shariah banking system for states
infrastructural development. In Middle East Nations, Lakhs of Keralites have been
engaging in different economic activities for their livelihoods and most of them are
Muslims. Unfortunately, the large percentage of these migrants are forced to come
back to state by the loss of jobs due to the negative result of global financial melt
down and current political uncertainty . State government has designed a policy to
utilize their money effectively for the economic development of our domestic
economy. The Kerala government has an intimate plan to use Islamic finance for
fulfilling our metro rail project and other road infrastructure. Already, the state
government has been designed an Islamic finance policy for the Cochin metro rail
project. Bihar chief Minister Nitish Kumar seeks benefits of Islamic finance for the
infrastructure development in the countrys most backward state. The officials of
National Committee on Islamic Banking, Indian Centre for Islamic finance (ICIF)
made a deep discussion with Chief Minister of Bihar for reaping the wide
opportunties of Islamic finance in states infrastructure development. They convinced
the CM high liquidity problem can solve through the flowing of large capital from
gulf nations. The kerala and Maharashtra states have already taken major steps for
Islamic finance to encourage their infrastructure development. Gulf finance, a
Bahrain based Islamic financial organization has invested $10 billion for building an
integrated economic zone in Mumbai. Where as the Government of Kerala plans to
accumulate another RS 1000 crores from gulf region for states infrastructure
development.
117
Graph 1: analysis of growing infrastructure in India and china
Source: India: Development and Policy Review
http://web.worldbank.org/WBSITE/EXTERNAL/COUNTRIES/SOUTHASIAEXT/0,,contentMDK:21002521~pageP
K:146736~piPK:146830~theSitePK:223547~isCURL:Y,00.html
Islamic micro finance, a new tool for poverty alleviation:

Poverty is one of the biggest constraints for economic development in low income
countries like india. Though, the number of people living in below poverty line has
been decreasing in the country, the rate of poverty remains in a big figure makes a
huge constraint to our economic growth. The World Bank estimated that poverty in
India was decreasing from 60% in 1981 to 42% in 2005.2 While share of people
living in poverty reduces on time to time, number of poor people are increasing due to
large increase in population. Eminent economists and policy makers argue that strong
weapons are needed for declaring a war on poverty. Many developing economies,
including India has been designed many policies and programmes for eliminating this
social evil from modern world, but no one made a positive result. Popularization of
2
New Global poverty estimates- what it means for India,

http://www.worldbank.org.in/wbsite/external/countries/southasiaext/indiaextn/0,,content
mdk:21880725~pagepk:141137~pipk:141127~thesitepk:295584,00.html
micro finance through Prof. Mohammed Unus and Grameen Bank lighten the new
hopes in the eyes of poor people in emerging as well as poorest economies. Micro
finance is an economic tool to alleviate poverty by supplying micro credit to poorest
communities at very low interest rate. Research report shows that almost 26.4 million
active borrowers involved in countrys micro finance sector in 2009.in India micro
finance industry have provided $4.4 billion micro loans to poors in 2009. Total
deposits and depositors were $204.9 million and 2.0 million respectively in the same
year.3 But Medias have leaked out news of exploitation by many MFIs in the
country. Reports prove that many micro finance institutions of the country behave
like a traditional money lenders by charging huge interest rate (mostly the rate
between20 to 40 per cent) for micro credit to the poor household. Besides, MFIs
harass its borrowers mentally and physically to recover the loan which is similar to
barbaric and inhuman methods of traditional money lenders. Already, the criticism
has arisen from many parts of country due to over exploitation of MFIs in India.
Andhra Pradesh State Government is forced to pass a law against the exploitative
interest system because, many poor people committed suicide in this agricultural
state. Reserve Bank of India (RBI) has been derecognized many micro finance
institutions in the country due to the over exploitation. Therefore, Islamic micro
finance being an alternative tool for poverty alleviation because it promotes an
interest free loans among poor households. In Islamic principles, poverty can alleviate
through charity and therefore, Islam promotes different instruments such as zadaqa
and Zakha(Muslim duty of donating 2.5% of profits) for economic welfare of poor
people. After the great success of Al-Khair Trust in Bihar, many interest free micro
finance credit societies are coming to front to remove socio-economic disparities and
to achieve justice and equity among socially, educationally and economically
backward classes. Sahulat micro finance society is one of them formed in New Delhi
in March 2010 with the objective of removing poverty from rural parts of the country.
Challenges for Islamic Banking and Finance in India

One of the biggest challenges for Islamic financial industry in India is to establish the
banking without interest system that essentially working on Islamic law (Sharia).
The Islamic financial system is an alternative economic mechanism, which fulfills the
desire of a man to bring the economic freedom in the country. This desire can only be
3
Micro finance in india: country profile,

http://www.mixmarket.org/mfi/country/India?gclid=CNLJ34OOi6oCFcl66wodzjLTxw 2009
119
fulfilled when RBI take the tremendous initiatives for Islamic financial system purely
working on the Sharia principles. The officials of RBI indicate that our prudent
banking laws are fully against sharia based banking system. India one of the dazzling
secularist nations strictly prohibits the operation of Islamic banks by regnant banking
regulation Act of 1949. Section 5(b) and 5(c) of this Act will not give any rights to
banks to invest their money on profit or loss sharing principle which is the basic
theme of all Islamic banks. Further, Section 21 supports the banks to deal with
interest on the payment of deposits and borrowings. Therefore, RBI necessarily
needed to make any required changes on its banking laws for smooth operation of
Islamic banks in the country which can possible through the special legislation in
Parliament. Unfortunately, our vote bank and religious politics withdraw RBI from
bears of new banking rules for Islamic banks. In Kerala, many criticisms have been
raised from political and social side, when Kerala State Industrial Development
Corporation (KSIDC), a state owned financial organization planned to open a Sharia
based financial institution with private players. Janata Party leader and former Union
Minister, Subramanian Swamy challenged the state governments decision in Kerala
High Court to run an Islamic bank by a state owned organization. He argued that
government action is completely against our secular principles which may claim for
religious financial institutions from other religions in future. After seeking the
opinion from RBI Governor Dr. Subha Rao, Kerala High Court finally restrained its
operation. The RBI Governor replied that it is not possible to allow any space for
Islamic banks in our economy by current banking laws. But, the RBI has no experts
in Islamic finance to evaluate the benefits of Islamic banks among Indian society. On
the other hand, we have very few Islamic economists; they continuously fail in
making awareness on Islamic banking and finance among the authority as well as the
people of this country.
Lack of specialists in Islamic finance is another big challenge for Islamic finance
industry in India. Generally, the most of Islamic financial institutions in our country
has been recruiting their staff from conventional banks mostly on the basis of
experience and not on the expertise in Islamic finance. The recruited conventional
bankers for Islamic finance is utterly failed in providing better services on Islamic
finance products for its customers due to the lack of knowledge in Islamic finance.
These bankers are neither awareness in shariah laws nor knowledge in Arabic.
Moreover, its is essential to provide any short term study program or training program
in Islamic banking for these bankers, which will aware them on shariah based
vocabularies like zadaka. Service of religious scholars are inevitable in all Islamic
banks to advice the banks on shariah issues. Globally, the range of Islamic scholars
who have expert knowledge of finance ranges from 50 to 260 we have no more
institutions or universities which offer the courses in Islamic banking and finance are
caused for resource problem in this sector in the country. The country has to give
priority for human capital development in islamic finance industry, by set up
education, training and research to supply the talent in islamic banking and finance in
the country.
The conventional banks have been giving a pre determined returns for depositors in
the form of interest. In Islamic financial system, depositors are treated as
shareholders of the bank and theres no guarantee of returns for investors deposit
with the bank. As I mentioned in the above parts, Islamic banks strictly operating
under the principle of shariah rules (Islamic law) which states that all the participants
of the bank including depositors are liable to share both profit and loss from any
economic activities undertaken by the bank. It means, if the bank makes huge profit
from their economic activities, depositors receive a proportionate share of it. On the
other hand, if the bank makes huge loss, depositors are liable to share a certain
percentage of it. We all know, the profits are uncertain in the future and therefore,
depositors has to share both profit and loss from economic activities. of return for
depostiors, but only return offer by the baks are profit sharing which is uncertain in
the future. Positive and nagtive rate of return.
The conventional economy uses the interest system as a prime tool for controlling
money supply and subsequently the inflation or deflation. The central banks in all
countries hike the interest rate for decreasing money supply during the time of
inflation and reduce the rate of interest rate for increasing money supply at the time of
deflation. Here, the interest tool is not only playing a key role for bringing price
stability in a national economy but also being a major part in making economic
growth in global economy. In India too, we are mostly depending the instrument of
interest for consistent growth and controlling inflation. But, Islamic economic
system is entirely free from interest (riba) and central banks of Islamic nations are not
admitting interest for stabilization of their economies. Due to the absence of
interest system on their economies, the Islamic nations loose an easy opportunity for
controlling inflation and supply of money from monetary side. Instead, they use
Islamic economic instruments such as
zakath, sadaqa for the best economic
management in their nations. Zakah and sadaqa systems help the Islamic economies
to redistribute income from rich to poor.
121
Obviously, we can praise the Islamic banks for protecting the people from
exploitation of conventional banks by supplying the interest- free loans to needy
persons. The critics of Islamic bank strongly argue that when Islamic bank provide
benefit to its customers in one way by providing interest free loans, they intensively
exploit its customers by charging high fee for all simple services of the bank in
another way. The customers of shariah banks frequently complain that the bank
charges higher fee than other conventional banks for its services. In South Africa,
certain Islamic banks such as Al- Baraka Bank, First National Bank has been
charging high fee for banks current and corporate account which caused the huge
criticisms from its Muslim customers. Therefore,
in India too, critics emphasize
the same issue if we open new window of Islamic bank in the country.
Islamic Economics: An illustration

Islamic economics studies the human survival (falah) on the basis of human
cooperation and participation by utilizing the whole resources of earth which is
considered to be the gift of Allah (God). The Islamic individual is social minded.
Therefore, the maximum social benefit will be the ultimate aim of an Islamic
economic activity. On other hand, the acquisition of wealth in the form of money or
commodities will be the major goal of human life in a conventional economy. The
Islamic economics universally propagates the moral and social values of the Islam.
The more importance for moral value than material value distinguishes the Islamic
economic theory from the principles of traditional economics. These moral values
discourage the man from economic competition and encourage living in human
cooperation and social relationships. In Islamic economic system, the private
ownership is countenanced within this moral framework. At the same time, Islamic
economics provides the social security to the poor by using its major tool, zakah
system. The principle of zakah supports the redistribution of income from rich to
poor. The Zakah system helps to eradicate the poverty and brings the equality and
social justice in all aspects of human life. The zakah system is also useful for
eliminating the concentration of wealth in a few hands. So then, the theoretical
viewpoints of Islamic economics are little different from the capitalistic and
socialistic economic pattern or its borrowed the concepts of mixed economic system.
The share of profit as well as loss (modaarbah) and the principle of zakah system
strengthen the economic cooperation on Islamic economy. The Islamic economics
has some variance to micro economic theory of classical and neo classical
economists. It gives the priority for value of simple living rather than the
consumerism and unlike the normal economics, the demand is creating through
infaq and equitable laws in Islamic economics. The Islamic economy strongly
opposes the production and consumption of forbidden products like alcohol, brown
sugar etc. In Islamic economics, the market mechanism is wide and comprehensive.
It favors free-market economy that means the price is determined by demand and
supply. The Islamic economy can never compromise with the market malpractices
such as hoarding with intention of raising the prices, collusion market to bid up prices
(tanaajush) and monopoly market, because Islam discourages the creation of money
on illegal ways. Islamic economic principles keep some repulsion from the Keynesian
macro economic principles. Islamic economics is not treating money as a commodity,
but it plays the role of medium of exchange and store of value only. Interest system is
another macro economic concept fully ignored by the Islamic economic theory.
Interest is paid on the cost of capital in conventional economics, but it has no role on
Islamic economy. Muslim economists believe that interest has a major role in
making the instability in international monetary system. Besides, the Islamic
economic law strictly prohibits the interest (riba) on capital, which would create an
exploitative society. Interest has been using as an instrument for controlling the
inflation in normal economy. In the conventional economics, the central bank of a
country hikes the interest rate for reducing the supply of money (monetary policy) to
escape from the higher inflation. But Muslim economists argue that interest rate and
inflation are positively related where the interest being the part of cost of production.
In most case, the higher interest rate will pull the economy to cost-pull inflation.
Conclusion
Efficient financial and legal mechanism is requiring for strong financial institutions in
low income country like India. The objective of every financial institution must be the
promotion of social as well as economic development of a country, because the
financial sector plays an active role in the rapid growth of an economy. Islamic
financial system helps to improve the risk assessment and risk management of the
financial institutions that would induce the level of confidents of creditors as well as
investors. It strengthens the whole activities of financial institutions. As a second
largest Muslim population state in the world, India not only can reap the benefits of
Islamic banking more effectively, but can attract more foreign institutional investors
(FIIs) from Middle East. Moreover, the concept of Islamic banking and finance can
create a strong economic fundamentals and strong financial systems in the emerging
123
economy of India. No doubt, the huge presence of Islamic banks will strengthen
financial institutions; encourage economic welfare and financial stability in our
nation. The Islamic financial institution can allocate more funds effectively for the
growth of agriculture and SME sectors. The financial inclusion on these sectors helps
the rural economy to achieve various socio-economic objectives such as poverty
alleviation, generation of more employment etc. The opening of new window for
Islamic banking and finance will improve the structure; resiliency and soundness of
financial sector in the country. The reforms on Islamic financial sector increase the
efficiency of financial institution and support the rapid growth of a countrys
economy. Islamic banking and finance not only the humanity and kindness, but also it
can be a part of the productivity of the economy.
References :
Book References:
Dr. Mohammed Muslehuddin(1993) Banking and Islamic Law published by Islamic Book
Service.
Dr. Monzer Kahf The Islamic Economy, Analytical study of the functioning of the Islamic
Economic System published by Muslim Students Association of the United States and
Canada.
Dr. Najatullah Siddiqui(2002) Some Aspects of Islamic Economy published by Markazi
Maktaba Islamic Publishers.
Dr. Najatullah Siddiqui(2003), Banking without Interest published by Markazi Maktaba
Islamic publishers.
Muhammed Akram Khan (1999) An Introduction to Islamic Economics (Kitab Bhavan, New
Delhi)
Allama Yusuf Al-Qardavi (2000) Economic Security in Islam (rendering into English by
Muhammed Iqbal Siddiqui and Published by Islamic Book Service)
Papers References:
M. Umer Chapra(October 2008), The global Financial Crisis: Can Islamic Finance Help
Minimize the severity and frequency of such a crisis in the future?
Dr. Mohammed Omar Farooq(September 2009), global financial crisis and the link between
the monetary and real sector: moving beyond the asset-backed Islamic finance
Dr. Sharique Nisar and Syed Kamran Razvi Regulating Islamic Finance in Secular
Countries: A Case Study of India
Mohammed Ghous Ikhtiyaruddin Bagsiraj (2005) Islamic financial institutions of India
progress, problems and prospects by Scientific Publishing Centre of King Abdul Aziz
University , Saudi Arabia
Current State of Indian Economy- June 2011 (report prepared by Economic Affairs and
research division, FICCI)
Mohammed Obaidullah (2008) Introduction to Islamic micro finance published by the
Islamic business and finance network, http://www.imad.in/mf-obaidullah.pdf
Amit Agarwal(2007)shariah complaint Islamic banking in India, a wealthy proposition
http://www.labnol.org/india/knowledge/sharia-compliant-islamic-banking-in-india-a-wealthyproposition/160/
Pawandeep(2008)islamic banking in india: a study of future potential http://www.crisil
.com/crisil-young-thought-leader-2008/dissertations/Dissertation_Pawandeep.pdf

Islamic Banking and Finance in India: Opportunities and Challenges

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Islamic Banking and Finance in India: Opportunities and Challenges

Uploaded by

Copyright:

Available Formats

Islamic Banking and Finance in India:

Opportunities and Challenges

Keywords: Financial Crisis, Islamic Bank, Modaarbah, Shariah, NBFI, Islamic

Lecturer in Economics, Irshadiya College, Calicut; Kerala