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ISLAMIC BANKING IN INDIA: AN OVERVIEW

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ZENITH International Journal of Multidisciplinary Research _________ISSN 2231-5780
Vol.9 (6), JUNE (2019), pp. 246-252
Online available at zenithresearch.org.in

ISLAMIC BANKING IN INDIA: AN OVERVIEW

MAHAMMAD SHAHID
LECTURER IN COMMERCE
THE YENEPOYA INSTITUTE OF ARTS, SCIENCE, COMMERCE AND MANAGEMENT
YENEPOYA (DEEMED TO BE UNIVERSITY)
MANGALORE, KARNATAKA, INDIA.
Email Id: shahidm@yenepoya.edu.in.

JEEVAN RAJ
LECTURER IN COMMERCE
THE YENEPOYA INSTITUTE OF ARTS, SCIENCE, COMMERCE AND MANAGEMENT
YENEPOYA (DEEMED TO BE UNIVERSITY)
MANGALORE, KARNATAKA, INDIA.
Email Id: jeevanrajkuthar@gmail.com.

ABSTRACT:
Islamic banking is the fastest growing feild in financial services, and opportunity abounds.
The main focus of Islamic finance is on transparency, cooperative ventures, risk sharing and
ethical investing which attracts a wide range of both Muslims and non-Muslims alike. Today,
Islamic banking has become one of the fastest growing segments of the international banking
and capital markets. Islamic banking is found in most parts of the world. Islamic Banking has
a huge market potential in India as India is the third largest Muslim populated country in the
world. Islamic banking is a system of banking with Shariah laws, which is against the
collection or payment of interest, commonly called ‘riba’. Islamic law also prohibits investing
in business that are considered unlawful or Haraam. The basic principle of Islamic banking is
based on risk sharing, which is a component of trade rather than risk-transfer which is seen in
conventional banking. This paper attempts to explain the basic principles and various
important products of Islamic banking. This paperfurther highlights SWOT analysis,
advantages of introducing Islamic banking in India and also identifies the limitations of
Islamic Banking in India.
KEYWORDS: Financial inclusion, Islamic banking, Muslims, Riba, Shariah, SWOT
analysis.

INTRODUCTION:
Islamic banking is the banking activity that follows the principles of Islamic law
(Shariah) and its practical application through the development of Islamic economics. Islamic
banking is also known as interest free banking which promotes profit sharing. Shariah
(Islamic Law) prohibits the charging and paying of interest which is Haraam (forbidden) in
Islam. It is very interesting that sharia banking is working without interest and is still
flourishing. They are not only profitable but are also growing at an astonishing rate in sense
of capital, assets and consumers. The biggest phase of development of Islamic financial
institutions occurred in 1980s. In 1985, the High Council of Organization of Islamic
Conference (OIC) declared takaful/Islamic insurance as Shariah compliant. The first Islamic
bank was established in 1963, in MitGhamr, in Egypt, but it did not last for long. In Gulf

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countries Islamic banking is common now. Islamic banking is steadily moving into an
increasing number of conventional financial systems. It is expanding not only in nations with
majority Muslim populations, but also in other countries where Muslims are a minority. As a
concept Islamic banking 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 some of the West Asian countries, Europe, and
The USA.The IMF has shown great interest in bringing about macroeconomic and financial
stability for its members who have adopted Islamic banking. 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
haveshown 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.

OBJECTIVES OF THE STUDY:

The objectives of this paper are-
 To explore the basic principles and concepts in Islamic Banking;
 To study Islamic banking by understanding various Islamic financial products.
 To analyze the advantages of Islamic banking in India.
 To understand the challenges for Islamic banking in India.

RESEARCH METHODOLOGY:
The study is mainly based upon the collection of secondary data. The secondary data
was collected from various sources of publications such as Magazines, Journals, Research
articles, Internet and un-published thesis.

LIMITATIONS OF THE STUDY:

 Time constraints
 The Study is based on Secondary Data
 All the data’s cannot be generalized

ISLAMIC BANKING –AN OVERVIEW:

Islamic Banking is the banking method which is based on Islamic Law (Shariah).
Islamic Law prohibits interest based banking and permits only profit sharing based banking.
The Holy Quran that says “Allah has allowed only legitimate trade and prohibits interest”. It
is against the interest, as interest is believed to lead to exploitation and unproductive income.
The purpose of Islamic banking has same purpose as conventional banking except that it
operates in accordance with the rules of the Shariah, known as Fiqh al-Muamalat (Islamic
rules on transactions). Islamic Banking does not mean a mere lending institution extending
interest-free loans, but a package of Shariah-compliant (strict adherence to Islamic economic
norms) financial services like Islamic bonds (sukuk), Islamic insurance (takaful), Islamic
mutual funds, Islamic credit cards and other technology-driven services like ATMs and
online banking, all of which have a tremendous market in India. In manyWestern countries
mainstream banks are now opening special no-interest divisions to cater toMuslim clients
who refuse to either pay or earn interest. But this is clearly the response to aniche-market of
clients with special needs. There is still a long way to go before the idea ofinterest-free
money is taken seriously by conventional bankers and policy makers.

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Vol.9 (6), JUNE (2019), pp. 246-252
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BASIC PRINCIPLES OF ISLAMIC BANKING:

 Receipt and payment of interest (Riba) is strictly prohibited.
 The business is based on sharing profit and loss.
 Certain industries, such as adult entertainment, alcohol, and gambling are disallowed
by Sharia and prohibited for investment. This is why Islamic Banking is also referred
to as Ethical banking.
 Banks may not lease or lend any product that they do not wholly own.
 Trading in debt is also not allowed, which is why Banks do not deal in traditional
bonds; rather they have their own version of such instruments called Sukuk (Islamic
Bond).
 Interest free loans are encouraged to spread financial inclusion.

ISLAMIC BANKING PRODUCTS:

Some existing Islamic modes of Finance
a) Mudarabah
Mudaraba is one of the popular Islamic banking products.Mudarabah is a form of
financing where an investor and an entrepreneur join hands. As per formal agreement drawn
between them, the investor provides funds whereas the entrepreneur uses his skills to earn
profit for their joint venture. In case of Islamic banks, depositors would be called Rub Al mal
and bank will be considered as Mudareb. The investor of capital is called Rub Al Mal and the
entrepreneur Mudareb.
b) Murabaha
Theterm Murabaha refers to a sale transaction with an element of profit for the seller
and has nothing to do with financing in its original sense. A Murabaha transaction entails sale
of goods by an Islamic bank to its customer with cost plus profit, usually on a deferred
payment basis.
c) Musharaka
In Musharaka a customer buy the banks’share of the ownership. The Customer is also
required to lease the bank’s part of ownership in the asset. Thus, customer actually makes
two periodical payments to the banks-one towards part purchasing the banks ownership in the
asset and the other being rent on leasing out the remaining part of the banks ownership in the
asset.

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

e) Ijarah
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. It is a lease agreement between the Islamic bank and
its client. The bank will possess the ownership of the asset.

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Online available at zenithresearch.org.in

f) QardHasan
Islamic banks lend loans keeping goodwill as the base. These loans are not charged
with profit or interest.The borrower is required to pay only the amount borrowed. These loans
do not charge the borrower the time value for the money. These loans are consistent with the
principle of prohibition of interest.
g) Halal Activities
Investing in any sinful (haram) activities are prohibited by Islamic Banks. . According
to Shariah Law, it prohibits business projects related to gambling, pork products, weapons,
defense, alcohol, pornography and any speculative activates.
h) Sukuk
An Islamic equivalent bond is termed as Sukuk. The investor of sukuknot only gets
share of an asset but also 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.

i) Wadiah
It is the acceptance of the sum of money for safe keeping. The sum of money
accepted will be repaid. Here banker is the keeper and trustee of funds. Bank is liable for safe
keeping of funds and on the demand of the customer it should be returned. As an appreciation
for keeping the funds with the banks, banker as its discretion shall reward the customer as an
appreciation (hibah).
j) 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 often used in the
agricultural sector in which without charging interest, the banks advances the money for
inputs and in return shall get a part of produce which will be sold after its delivery.
k) Waqf
It refers to a voluntary dedication of one’s property and wealth. This
voluntarydedication should be exclusively for religious purposes.The waqfproperty can
neither be sold nor inherited or donated to anyone. It should be used for Shariah compliant
projects only.

ADVANTAGES OF ISLAMIC BANKING IN INDIA:

The Islamic community could benefit from the initiative of Islamic banking to a large
extent. Islamic banking can be an alternative to conventional Banking with different financial
products but same goal of financial inclusion to be achieved. Islamic banking is not just for
Muslims alone. It is available to non-Islamic community which can have a wider range of
choices. The various advantages of Islamic banking are:

a) Financial Inclusion
A focus on financial inclusion has led to RBI and Government under Jan DhanYojna
to bring the unbanked and financially excluded population under the formal banking system.
Conventional banking system may be for some Muslims unacceptable as it is not in
conformity with the Islamic law. Thus they remained excluded from conventional banking
system. For the Muslims Islamic Banking could open new doors, enabling the betterment of
this community and achievement of the goal of financial inclusion for all.

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b) Inclusive Growth
The goal of Inclusive growth can be fostered with Islamic banking as easier and cheap
credit can be provided to large number of people with little or no collateral which can help to
penetrate the banking facilities to lowest strata.

c) SubstantialFlow of Funds
Substantial flow of fundsIslamic banking will open avenues for flow of substantial
funds in the market. It will help in mobilize large amounts of money from Muslims who
participate very little or not at all in conventional banking system.

d) Investment from Gulf

Investment funds fromGulf countries Islamic banking will also help to channelize
huge amount of Islamic investment funds from the Gulf countries that India is currently
losing to other countries. It could help to foster dealings with Muslim dominated countries.

e) Prohibition of Haraam Activities

Islamicbanking prohibits investment in activities which are considered “haraam”
under Islam such as gambling, alcohol, weapon, pornography etc. and promotes investment in
real economic activities that shall lead to social welfare on the whole.

f) Wider Financial Choices

Wide range of financial products will be available to people as new modes of
financing are introduced under Islamic banking. An alternative system of banking could
promote competition, innovation, and efficiency.

g) Niche Market
Islamic banking is tailor made to meet the requirements of Muslim community which
does not participate in conventional banking system due to their religious beliefs. As the
demand for niche products is increasing in India, Islamic banking could prove to be
beneficial for India.

CHALLENGES FOR ISLAMIC BANKING IN INDIA:

After many discussions, debates, meeting, committees held to weigh the pros and
cons of Islamic Banking, it has not been implemented in India because of the following
barriers-
a) No Pre-determined Return in the Form of Interest
Conventional banks raise the depositsonly after a promising a pre-determined rate
ofreturn on their deposits. However, returns underIslamic banking system will be determined
onlyafterwards which is unviable under currentbanking system.
b) Difficulties to Comply with SLR Requirements
Banks have to comply with theSLR requirements of RBI under which thecommercial
have to keep their funds in liquidform. A large amount of funds are locked up ascash, gold
and government securities. Governmentsecurities are interest bearing, gold is risky asprice
fluctuates and cash does not offer any return,making it unacceptable under Shariah Law.
c) Destabilize Secular Nature
It is argued that Islamic banking will destabilize the secular nature of the banking
system of India. By amending banking and taxation laws to conform to a particular religion is
going against the secular fabric of our nation.

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d) Conduit of Terrorism Activities

Concerns are being raised that Islamic banking can also open channels for terrorist
groups to channel money into India.
e) Political Weapon
Islamic banking can be politically exploited and used as a political weapon. Any step
to introduce Islamic banking can be interpreted as appeasing Muslims.
f) Lack of Experts
Lack of experts to develop a proper framework for Islamic banking in India also poses
a barrier.

g) Misconception that Islamic banking is only for Muslims

Islamicbanking is having the misconception that it is meant onlyfor Muslims. Islamic
banking is an alternative to conventional banking which is meant for people for all religions.
Muslims who do not depend upon conventional banking as it does not confirm with the
Shariah Law and remain financially excluded will majorly benefit from it. However, it is
open for all.
Islamic banking has barriers in India but it can be addressed with some flexibility
andmodifications in regulations which ultimately depend upon the political will. With huge
marketin India, influence from Muslim community forIslamic banking and recommendations
byRaghuramRajan Committee on banking sector reforms, prospects seem better for Islamic
bankingin India. Many countries have adopted Islamic banking which operates along with
conventionalbanking. An analysis of this mixed bankingsystem in different countries can be
made foraddressing operational issues in India.

SWOT ANALYSIS OF ISLAMIC BANKING:

STRENGTHS WEAKNESSES
 Consistent with Shariah Law  Lack of Shariah experts
 Consistent with religious beliefs of  Banking Regulation Act need to be
Muslims modified.
 Not debt based like conventional
banking
 Financial Inclusion
OPPORTUNITIES THREATS
 Attract investments from cash surplus  Micro finance may act as competitor
Muslim countries  Political turmoil
 Large Population of Muslims  Competition from conventional banking
 Inclusive growth  Implementation of the uniform civil code
will affect the Shariah laws/ instructions.
 Conduit of terrorism
 Secular Nature will be destabilized.

CONCLUSION:
The benefits highlighted in the paper suggests that Islamic banking has many
advantages over conventional banking and the major being that it has the potential to increase
financial inclusion which is crucial if India wants to become an economic giant in the near
future. India, however, has been shying away from Islamic banks. The reason for the same is

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Vol.9 (6), JUNE (2019), pp. 246-252
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probably more political than economic.The SWOT analysis undertaken for Islamic banking
in India also reveals that India should open its doors to Islamic banking as the strengths and
opportunities far out-weigh the weaknesses and threats. Thus, Islamic banking would be
another alternative mode of banking that would strengthen market efficiencies with
innovations and competition.

REFERENCES:
 Viverta, B. K.andSkully, M. (2007), “Efficiency Analysis of Islamic Banks in Africa,
Asia and the Middle East”, Review of Islamic Economics, Vol. 11, No. 2, pp. 5-16.

 Majid, K. (2012), “Efficiency Analysis by Using Data Envelopment Analysis Model:

Evidence from Indian Banks”. International Journal of Latest Trends in Finance
andEconomics Science, Vol. 2, No. 3, pp. 238-237.

 Iqbal, M. (2001),“Islamic and Conventional Banking in Nineties: A Comparative

Study”. Journal of Islamic Economic Studies, Vol. 8, No. 2, pp. 1-28.

 Al-Qudah, A. M., &Jaradat, M. A. (2013),“The Impact of Macro Variables and Banks

Characteristics on Jordanian Islamic Banks Profitability”, Empirical Evidence.
International Business Research Journal, Vol. 6, No. 10, pp. 153-162.

 Bhat, A. S. & Dar, A. M. (2015), “Islamic banking an emerging global industry: its
scope in Kashmir.”
Retrievedfrom: http://muslimmirror.com/eng/islamicbanking-an-emerging-global-
industry-itsscope-in-kashmir on November 11, 2016.

 Khan, M.A. &Hussin, N., 2013. Islamic Banking in India: Developments, Prospects
and Challenges.
Retrieved from: http://papers.ssrn.com/abstract=2223935 on December 1, 2016.

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