What is Islamic Banking & How does India benefit from it?

In order to understand the relevance and future of Islamic banking in India, we need to consider the underlying situation of Muslims in India and the opportunity Islamic banking provides to them.

Islamic Banking
Islamic Banking

Islamic Banking is a comparatively new term for Indian economy because of the fact that not much debate has taken place regarding this. It is now pertinent to mention that RBI has mooted a proposal to introduce this system of banking in India in the coming years. Some people have welcomed the move whereas some have criticised the same vehemently.

What is Islamic Banking, by the way?

Well, we have talked too much about the new style of banking that will be introduced in the near future in a phased manner but the real nature of it is yet to be explained. Islamic Banking refers to the phenomenon of banking activity that complies with the Shariat law. It implies that the laws of the Shariat should be practically implemented in banking activities and Islamic finance. The more appropriate name for it should be ‘Shariat Compliant banking’.

The main principle of this type of banking is that it prohibits taking interest from people for loans given to them. That is considered Riba in Islam. On the other hand, something that is prohibited in Islam should not be financed through this banking system such as alcohol, pork etc.

Now the question arises is that the way this system runs since there is no interest income? Banks need to thrive on the profit they make from loans but here no such way is there. Actually, Islamic banking is based on the concept of profit and loss sharing. It says that you cannot earn undue interest but you can earn reasonable profits from an investment made with an element of calculated risk on the part of the investor. Thus Islamic banks are free to provide accounts where there is profit or loss instead of interest. The banks collect this profit and invest in something that is Sharia-compliant such as Sharia-bonds etc. This way, it earns and can sustain in the long run.

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Islamic Banking: Tracing the development

Islamic banking has taken its root from a financial organisation called Tabung Haji in Malaysia which started this trend after seeing the demand for interest-free money needed for pilgrimage purpose. In 1963, this bank came into being with 1281 depositors which soon touched the 8 lakh mark. After that, the Islamic banks became popular in Egypt. In the recent years, Islamic Development Bank has seen its rise with a view to promoting Sharia-compliant banking in the world. 

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Islamic Banking and India: The way forward

RBI has recently floated an opinion that there should be a separate Islamic banking window in the conventional banks so that Islamic banking can be promoted in our country. But how is the concept relevant in our country? What are issues that may be faced by this type of banking in the future? These are the issues that need to be sorted out first before we can see this new type of banking taking the centre stage in India.

  • Banking Regulation Act needs to be amended: The first and foremost thing is that the prevalent Banking Regulation Act 1949 will need to be changed in case Islamic banking is introduced in India. It defines taking interest for loans as a primary activity for banks but the same is a strict no-no in Islamic banking. 
  • It is an opportunity for Financial inclusion: India is taking every possible step towards achieving financial inclusion in our country. A large number of Muslims are not covered by banking services as of now. This in the way will be a huge step towards achieving financial inclusion in India. 
  • Islamic banking is a big opportunity for investment: This is because most of this is untapped as of now. In India, the Muslim population is huge and the share of Islamic finance in the global economy comes to around 1%. If these people come forwards for taking loans without interest, more jobs will be created and at the end, Indian will experience a higher GDP per capita income. 
  • Indian stock market is ready for it: Indian stock market is ready for Islamic banking because they are more Sharia-compliant as compared to countries such as Pakistan, Malaysia etc. The age-old Bombay Stock Exchange even has a separate Islamic finance training centre exclusively for this purpose. 
  • Indian banking sector is not ready at all: Islamic banking is completely different from the conventional banking. It runs on the basis of profit and loss instead of interest income. In this regard, it should be kept in mind that banking sector is not acquainted with it and it requires time to understand and apply this concept. However, a gradual introduction will not be much of harm for India. 
  • This is a way for Indian Muslims to turn into entrepreneurs: The simple reason is that you do not have to pay interest on loans taken from banks. You just need to have a proper project execution plan ready and you can approach the bank for taking a loan. It will be helpful for setting up that startup business you have been dreaming of and who can say you won’t be the next Steve Jobs or Mark Zuckerberg? 
  • It will tap into the huge resources with Muslim community: Due to the backwardness of the community in our country, the money with them never finds its way into the banking system. Islamic banking can change that and this way, the circulation of money is set to increase. Islamic banking provides with an opportunity to tap into the resources of the community. India needs money for big ticket investments in the different sectors and this can be a welcome opportunity to arrange funds for that. 
  • It is a big industry and India needs to take advantage of it: As estimated, the Islamic finance industry is around $3 billion around the world and it is going to double by the year 2020. It is a great opportunity for India with a huge Muslim base to start offering this product so that more people who are otherwise excluded from conventional banking because of religious thinking, can take advantage of it in India.

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Islamic banking is a comparatively new concept for India. However, it should be noted that China, USA, UK etc have already made enough progress in this regard despite being non-Muslim countries. India is sitting on a pile of potential and Islamic banking is going to be beneficial for the country given the Muslim base and the untapped resources in the country. The move by the Central Bank is in the right direction and in the years to come, the modalities need to be formulated so that the going gets easier. Islamic banking is the future and India can reap rich dividends from it.

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