Scope of Islamic banking in India

Anjuman-I-Islam’s
Allana Institute of Management Studies
Project on

ISLAMIC BANKING

Presenter:
Shaikh Shoaib (MFM – 13)
© 2012 Shoaib Shaikh. All rights reserved.

AGENDA
1

Overview of Islamic Banking

2

History of Islamic Banking

3

Largest Islamic Banking

4

Principles of Islamic Banking

5

Fundamentals of Islamic Finance

6

Performance of Islamic Banks vs. Conventional banks

7

Share of Islamic Banks in Total Banking System

8

Scope of Islamic Banking in India

9

Bibliography


Overview of Islamic Banking
Islamic banking ‎s banking activity that is consistent with the principles of sharia Law and its
i
practical application through the development of Islamic economics.
 Sharia prohibits the fixed or floating payment or acceptance of specific interest or
fees also known as riba for loans of money.
 Investing in businesses that provide goods or services considered contrary to Islamic
principles is also haraam
 Derived from three sources:
 Quran, revelation from Allah
 Sunnah, authentication sayings & actions of Prophet Muhammad (Sallal laho
Alahi Wassalam)
 Fiqh, Collection of interpretations / rulings / precepts based on the Quran and
Sunnah.

History of Islamic Banking
The first instance of Islamic banking came into the picture in Egypt in 1963. The pioneering
efforts by Ahmad El Najjar brought this bank into existence, whose key principle was profit
sharing (non-interest based philosophy of Shariah).
 By the end of 1976 there were 9 such banks in the country
 In 1971, Nazir Social Banks is known to be the first commercial bank in Egypt

 The first bank explicitly based on Shariah principles was established by the
Organization of Islamic countries (OIC) in 1974, called Islamic Development Bank
(IDB).
 The biggest change in terms of adaptability came in 1991 when the Accounting
and Auditing Organization for Islamic Financial Institutions (AAOIFI) was
established to advise on Islamic finance standards all over the world


Largest Islamic Banking
Shariah-compliant assets reached about $400 billion throughout the world in 2009,
according to Standard & Poor’s Ratings Services, and the potential market is $4 trillion.
Iran, Saudi Arabia and Malaysia have the biggest sharia-compliant assets.

 In 2009 Iranian banks accounted for about 40 percent of total assets of the
world's top 100 Islamic banks.
 Bank Melli Iran, with assets of $45.5 billion came first, followed by Saudi
Arabia's Al Rajhi Bank, Bank Mellat with $39.7 billion and Bank Saderat Iran
with $39.3 billion.
 Iran holds the world's largest level of Islamic finance assets valued at $235.3bn

 Six out of ten top Islamic banks in the world are Iranian


Principles of Islamic Banking
Islamic banking has the same purpose as conventional banking: to make money for the
banking institute by lending out capital. But that is not the sole purpose either as Islam
forbids simply lending out money at interest. The basic principle of Islamic banking is
based on risk-sharing
Islamic rules on transactions (known as Fiqh al-Muamalat) have been created to prevent
this evil.
Islamic banking introduces concepts such as
 Profit sharing (Mudharabah)
 Safekeeping (Wadiah),

 Joint venture (Musharakah),
 Cost plus (Murabahah),
 Leasing (Ijar)

 Qard Hassan/ Qardul Hassan

Profit Sharing (Mudharabah)
Mudarabah" is a special kind of partnership where one partner gives money to another for
investing it in a commercial enterprise. The capital investment comes from the first partner,
who is called the "rabb-ul-mal", while the management and work is the exclusive
responsibility of the other party, who is called the "mudarib".
The Mudarabah (Profit Sharing) is a contract, with one party providing 100 percent of the
capital and the other party providing its specialist knowledge to invest the capital and
manage the investment project. Profits generated are shared between the parties according
to a pre-agreed ratio. Compared to Musharaka, in a Mudaraba only the lender of the money
("rabb-ul-mal") may incur a loss.


Safekeeping (Wadiah)
In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds in
the bank and the bank guarantees refund of the entire amount of the deposit, or any part
of the outstanding amount, when the depositor demands it. The depositor, at the bank's
discretion, may be rewarded with Hibah as a form of appreciation for the use of funds by
the bank.

Hibah:
 This is a token given voluntarily by a debtor to a debitor in return for a loan.
 Hibah representing a portion of the profit made by using those savings account
balances in other activities.
 It appears similar to interest, and may, in effect, have the same outcome
 Hibah is a voluntary payment made (or not made) at the bank's discretion, and cannot
be 'guaranteed’
 It is not time bound but is at the bank's discretion

Joint Venture (Musharakah)
Musharakah is a relationship between two parties or more that contribute capital to a
business and divide the net profit and loss pro rata.
 This is often used in investment projects, letters of credit, and the purchase or real
estate or property.
 In the case of real estate or property, the bank assess an imputed rent and will share it
as agreed in advance
 All providers of capital are entitled to participate in management, but not necessarily
required to do so.
 The profit is distributed among the partners in pre-agreed ratios, while the loss is
borne by each partner strictly in proportion to respective capital contributions.
 This concept is distinct from fixed-income investing (i.e. issuance of loans).[


Cost Plus (Murabahah)
This concept refers to the sale of goods at a price, which includes a profit margin agreed
to by both parties. The purchase and selling price, other costs, and the profit margin
must be clearly stated at the time of the sale agreement.
 The bank is compensated for the time value of its money in the form of the profit
margin.
 This is a fixed-income loan for the purchase of a real asset (such as real estate or a
vehicle), with a fixed rate of profit determined by the profit margin.
 The bank is not compensated for the time value of money outside of the contracted
term (i.e., the bank cannot charge additional profit on late payments); however, the
asset remains as a mortgage with the bank until the default is settled.
 This type of transaction is similar to rent-to-own arrangements for furniture or
appliances that are common in North American stores.


Leasing (Ijarah)
Ijarah means lease, rent or wage. Generally, the Ijarah concept refers to selling the benefit of
use or service for a fixed price or wage. Under this concept, the Bank makes available to the
customer the use of service of assets / equipments such as plant, office automation, motor
vehicle for a fixed period and price.
Ijarah Thumma al bai' (Hire purchase)
Parties enter into contracts that come into effect serially, to form a complete lease/
buyback transaction.
The first contract is an Ijarah that outlines the terms for leasing or renting over a fixed
period, and the second contract is a Bai that triggers a sale or purchase once the term of
the Ijarah is complete. For example, in a car financing facility, a customer enters into the
first contract and leases the car from the owner (bank) at an agreed amount over a
specific period. When the lease period expires, the second contract comes into effect,
which enables the customer to purchase the car at an agreed to price.
The bank generates a profit by determining in advance the cost of the item, its residual
value at the end of the term and the time value or profit margin for the money being
invested in purchasing the product to be leased for the intended term.

Qard Hassan/ Qardul Hassan (good loan/benevolent loan)
This is a loan extended on a goodwill basis, and the debtor is only required to repay the
amount borrowed. However, the debtor may, at his or her discretion, pay an extra
amount beyond the principal amount of the loan (without promising it) as a token of
appreciation to the creditor. In the case that the debtor does not pay an extra amount to
the creditor, this transaction is a true interest-free loan. Some Muslims consider this to
be the only type of loan that does not violate the prohibition on 'riba, for it alone is a
loan that truly does not compensate the creditor for the time value of money


Fundamentals of Islamic Finance
The term “Islamic banking” refers to a system of banking or banking activity that is
consistent with Islamic law (Shariah) principles and guided by Islamic economics. In
particular, Islamic law prohibits usury, the collection and payment of interest, also
commonly called riba in Islamic discourse.
In addition
Islamic law prohibits investing in businesses that are considered unlawful, or haraam (such
as businesses that sell alcohol or pork, or businesses that produce media such as gossip
columns or pornography, which are contrary to Islamic values).
Furthermore the Shariah prohibits what is called "Maysir" and "Gharar".
Maysir is involved in contracts where the ownership of a good depends on the occurrence
of a predetermined, uncertain event in the future whereas
Gharar describes speculative transactions. Both concepts involve excessive risk and are
supposed to foster uncertainty and fraudlent behaviour. Therefore the use of all
conventional derivate instruments is impossible in Islamic banking.


Performance of Islamic Banks vs. Conventional banks
Islamic banks have proved to be a viable and
efficient way of financial intermediation in the
Middle East. According to a recent IMF study,
the probability for Islamic banking to develop in
a given country rises with the share of Muslim
population, per capita income, and the
country’s net export of oil. The distance to the
two main Islamic financial centres, Bahrain and
Malaysia, does matter for the diffusion of
Islamic banks across countries. Islamic banks
diffuse faster when a country is closer to one of
the above two centres. If the importance of
Islamic banks in the economy by assets is
measured, in almost all countries having Islamic
banks, except Iran, the ratio of credit of
conventional banks to GDP is substantially
higher than the investment to GDP ratio of
Islamic banks, which accounts for less than 20
percent of GDP in most countries

Comparing Investment by Islamic Banks
with Credit by Conventional Banks
in Selected Countries
(average 1992-2006, percent of GDP)

Share of Islamic Banks in Total Banking System in
Selected Countries

“Islamic finance is poised to play a bigger and more central role in global finance.”
Lim Hng Kiang, Minister for Trade and Industry, Singapore

Even after forty years, since nationalisation of the banks about 60% population do not have
access to formal banking and only 5.2 % of villages have bank branches. The financial
exclusion of a large segment of the population has far-reaching implications for the socioeconomic and educational uplift of the masses. These financially excluded classes would not
hesitate in sharing a “return on their investment but they often find it difficult to meet the
demand of a pre determined return unrelated to the yield. If finance is available without the
burden caused by pre-determined interest rates, it will be a welcome development for the
marginalized and also especially for same. Interest-free Islamic Banking can fill up this gap.
For Muslims, as per the Sachar Committee report based on census 2001 data, the percentage
of household availing themselves of banking facilities is much lower in towns and villages
where the Muslim population is high. This is due to a certain mindset prevailing in the
banking sector which has categorized Muslims and Muslims dominated areas as Negative
Zones as documented in Sachar report. Prohibition of interest and thus for reasons of faith
Muslims are away from the conventional banks as referred to in the report of the Committee
on Financial Sector Reforms of the Planning Commission headed by Dr. Raghuram Rajan


In the absence of an alternative to the convention based on interest, in the state of Kerala
where Muslims make up around 25% of the population of Kerala, which was 31.8 million
according to the 2001 Census, it is reported that thousands of crores earned in interest is
kept in suspended accounts, as believers do not claim it. Muslims both rich as well as those
employed in the Gulf invest their money on gold and real estate which are not productive
investments. They also indulge in lavish spending in marriages and other rituals and many
of them fall into trap of bogus financial institutions lose their hard earned money
The collapse of leading Wall Street institutions, notably Lehman Brothers, and the
subsequent global financial tsunami and economic recession, Islamic banking is seriously
being considered and has emerged as a possible alternative to the conventional banking
because of the followings:
• It is based on Ethical and Socially Responsible Investments (SRI)
• It aims at Equity and Justice and leads to poverty alleviation and
• It acts to new dimension to assets and actual projects aiming to support real
economic growth instead of financial engineering.
• It provides services to under banked populations ignored by conventional banks

In 2005, Government of India asked Reserve Bank of India to examine Islamic banking
instruments and constituted a Working Group headed by Mr. Anand Sinha, Chief Manager,
Department of Banking and Operation and Development along with senior Bankers from
SBI, ICICI and Oman International Bank that came up with its report in 2006 which said: In
the current statutory and regulatory framework it would not be possible for banks in India
to undertake Islamic Banking activities and concluded that if the banks are allowed to do
Islamic banking appropriate amendments are required in Banking regulations Act 1949.
Another significant development has taken place in the state of Kerala. Govt. of Kerala
under KSIDC (Kerala State Industrial Development Corporation) has taken a courageous and
commendable step to form an Islamic Investment company named Al Barakah Financial
Services Company, an NBFC after an exhaustive feasible report undertaken by a reputed
international consulting firm Ernst & Young. This NBFC will be turned into a global Islamic
bank as soon as the RBI accommodates it after an amendment in the Banking regulations.
Dr. Subramaniam Swamy has submitted a petition in the High court to stop the
participation of the Kerala Government. Admission of his petition has put a hold on the
proceedings for the time being.

Bibliography

 http://www.wikipedia.org/

 http://shariah-fortune.com/history-of-islamic-banking

 www.ftkmc.com/newsletter/Vol1-25-sep6-2010.pdf

 http://investindia.kotak.com/media/scope-of-islamic-finance-in-india.html

Scope of Islamic banking in India

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