Islamic Banking: A greater option to avoid Riba
Fahid Fayaz Darangay
Islamic banking is a banking system in accordance with the Shariat. In Islam, money has no intrinsic value – money, therefore, cannot be sold at a profit and is permitted to be used as per Shariat only. The Islamic Law or Shariat prohibits paying any fee for renting of money (called riba) for specific periods of time. It also prohibits any sort of investment in businesses that are considered haraam or against the principles of Islam. It is largely believed that these principles have been derived from the Quran and have been in practice since then.
History: While the initiation of modern Islamic Banking dates back to 1963, the present-day practice debuted in 1975, when banks were established and mandated to operate in adherence to Shari’a rules and principles. Ever since, Islamic Banking has been one of the fastest growing sectors in the global banking industry. As new geographies continue to open up to Islamic Banking, industry forecasts suggest that Islamic Banking assets held by commercial banks globally will continue to grow.
The pace of growth has increased dramatically over the past decade driven by awareness and demand, as well as easier access to Islamic Banking services. Across world markets, and particularly in the GCC, South-East and South Asia (which is home to over 50% of the total Islamic Banking industry), the strategy has been to allow a dual banking system, whereby Islamic Banking co-exists with conventional banking.
The growth of the Islamic Banking industry has been fuelled by surging demand for Shari’a-compliant products, not only from financiers in the Middle East and other Islamic countries, but also by investors worldwide, thus making it a global industry. Besides its vast geographical expanse, Islamic Banking is witnessing rapid expansion across the whole spectrum of financial activities including personal banking, insurance and capital market investments. The continued growth in the Islamic banking industry is attributable to three factors: increasing demand from a large number of Muslim communities (including Muslim immigrants to western countries); oil wealth in GCC countries; and the growing attractiveness of Shari’a-compliant financial services to non-Muslim investors seeking ‘ethical’ investments and banking practices.
Oman’s Islamic banking (including Islamic windows) is expected to continue its steady growth over the coming years. Reports and banking experts are also expecting that Oman should witness a growth of sukuk as local and regional players look to raise funds in a Shari’a compliant manner.
Working: Islamic Banks work on the principles of an interest free banking. Riba or interest under Islamic Law basically means anything in “excess” – the investor should not make an “undue” profit from the hard work of the other. But it is permitted to follow a system of reasonable profit and return from investment where the investor takes a risk that is well calculated.
Thus, Islamic banks make available accounts which provide profit or loss instead of interest rates. The banks use this money collected by them and invest in something that is Shariat compliant, that is not haraam and does not involve high risks. Thus, businesses involving alcohol, drugs, war weapons etc. as well as all other high risk and speculative activities are prohibited. Islamic Banking, therefore, acts as an agent by collecting the money on behalf of its customers, investing them in shariat compliant projects and sharing the profits or losses with them. The Dow Jones Islamic Market Index came into being in the year 1999 for investors willing to invest in shariat compliant projects.
There are various products in Islamic Banking that cover the needs and requirements of the consumers. Some of them are Mudarbah (profit sharing – one party provides finances, the other provides expertise), Musharaka (joint venture – both parties share everything equally), Murabaha (cost plus profit), Ijara (letting on lease), Istisna amongst others.
The concept of Islamic banking has often been criticised by both purists as well as modern conventional bankers. It is stated that the instruments in Islamic banking are essentially the same as the ones in traditional banking and have the same purpose with merely different terminology.
It is often stated that in today’s time of profit maximisation there is a thin line between riba and profit. The modern Islamic Banks have found ways to work around the conventional instruments and include them in Islamic banking instruments. One such example is an instrument called mudarabah, which is essentially nothing else but a mortgage and the banker ends up earning an interest in the form of mortgage interest rate on it. There are arguments that Islamic Banking was based on high ethical principles which no longer remain the same. A World Bank paper states that conventional and Islamic banking methods are very similar to each other. Another criticism is that the Islamic bankers find their way around the system and “manage” to get a shariat compliance certificate from a scholar to invest in.
However, Islamic banking across the globe is at a comparatively nascent stage and there are plenty of interpretations given by scholars worldwide with regard to various Islamic finance instruments. One cannot completely stick to the purist approach, as the Islamic finance system is centuries old and the modern Islamic Banking system is a recent evolution. The Islamic finance system has to evolve with time without violating the fundamentals of Islamic Finance system as per the shariat
Responsibility: The Islamic banks have significant roles in the social responsibility. Moreover, the core and guidelines of Islamic economics spontaneously achieve the justice and equality, an example for that, the Zakat payment on annual basis by the Islamic banks which goes to the needy people and zakat channels as outlined in the Holy Quran, as it helps in alleviation of poverty. Zakat is a religious levy deducted from the bank net income and to be paid annually. Further, the microfinance products contribute in achieves some balance in the community by financing the limited income category.
Social responsibility of Islamic banks refers to all activities carried out by it, to accomplish religious, economic and ethical responsibilities. In other words, Islamic banks are responsible and obligated towards community to carry out a fully Shari’a-compliant banking and services, and to obey the rules of Islam in all dealings and businesses, this is in regard to the religious responsibility. In respect to the economic responsibility, Islamic banks should conduct a profitable and financially viable business and reserve and develop the moneys of the Shareholders and Depositors. Ethical responsibility refers to the obligation of the Islamic banks to respect and value the community religious and customary norms which are not codified in laws.
In non-Muslim dominated countries:
Introduction of Islamic Banking was mooted by Raghuram Rajan in his report on the Financial Sector in the year 2008 where he recommended that interest-free banking techniques should be operated on a larger scale so as to give access to those who are unable to access banking services, including those belong to economically disadvantaged section of the society.
There are many advantages in introducing an Islamic window in the banks. For instance, majority of companies in the Stock Exchange are Shariat compliant (this number is more than the Shariat complaint companies on the Stock Exchange in Malaysia), thus this would result in attracting huge funds in the domestic market alone.
An Islamic Banking window will encourage many from the Muslim community to come forward and invest in projects thereby mobilising huge amount of capital which they may not be willing to put in the banks. This also means that India will be able to attract huge investments from West Asia and from those who invest only in shariat compliant projects.
However, the Indian banking laws will have to be amended so as to incorporate the provisions relating to Islamic banking. For example, the Banking Regulation Act requires payment of interest which is against the principles of Islamic Banking. The Act also specifies “banking” to mean accepting deposits of money from public for lending or investment, thus excluding within its ambit the instruments of Islamic banking that promote profit and loss.
The recent proposal of RBI for opening of an Islamic Banking window has received mixed reactions from many especially in the light of the recent Uniform Civil Code debate and is likely to take a political angle instead of a financial one.
It is pertinent to highlight that investing in shariat compliant projects though Islamic Banking windows is something that is mandatory in nature for Muslims, unlike personal laws. For everyone, it will just be an additional financial investment opportunity. It is important to remember that using banking services of one kind need not interfere with the use of another.
(The author is currently pursuing Masters in Financial Economics from Madras School of Economics, Chennai. He is a regular contributor to Kashmir Vision)
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