Islamic Banking

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  • 1. DECLARATIONThis is to certify that present project report entitled “ISLAMIC BANKING-MAKINGA BETTER SOCIAL AND FINANCIAL WORLD “is based on my original researchwork and indebtedness to other work duly acknowledged at relevant places.The project report has not been submitted either in part or full for any other degree ordiploma for any other University------------------------------- -------------------------------- (Supervisor) (Student) 1
  • 2. ISLAMIC BANKING-MAKING A BETTER SOCIAL AND FINANCIAL WORLDProject report submitted to Department of Commerce, Zakir Husain College, andUniversity of Delhi in partial fulfillment of the requirement of B.Com (H) Part – IIIExamination. Submitted by SOOBIAN AHMED B.Com (H) III yr. Roll No 07/546 2009-10 Under supervision Of DR.ABDUL WAHID FAROOQI Department of Commerce Zakir Husain College University of Delhi New Delhi-110002 2
  • 3. First of all I would like to express my gratitude to my Mentor, who guided me withhis knowledge and skill and helped me in successful completion of the work.I gratefully acknowledge my project guide and my Mentor DR. ABDUL WAHIDFAROOQI. The support and guide that was provided to me lead to thesuccessful completion of this project.I am grateful to him for his great support and help all throughout the project. I amthankful to him for taking out time and pointing out the multitudinous aspects ofIslamic banking and helping me increase my learning out of the project.I would heartily thank all my friends without whose support & valuable inputs thisproject would not have been completed. B.Com (H) III yr. Roll No 07/546 3
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  • 7. "People think the Islamic Banking system is basedon faith, but its based on justice. The system isbased on justice for the two parties and how youget to the justice is extracted from Islamic faith" BRIEF HISTORY OF BANK:The first state deposit bank, Banco di San Giorgio (Bank of St. George), was founded in 1407 atGenoa, Italy.The name bank derives from the Italian word banco "desk/bench", used during theRenaissance by Florentine bankers, who used to make their transactions above a desk coveredby a green tablecloth. However, there are traces of banking activity even in ancient times.In fact, the word traces its origins back to the Ancient Roman Empire, where moneylenders wouldset up their stalls in the middle of enclosed courtyards called macella on a long bench called abancu, from which the words banco and bank are derived. As a moneychanger, the merchant atthe bancu did not so much invest money as merely convert the foreign currency into the onlylegal tender in Rome—that of the Imperial Mint.The earliest evidence of money-changing activity is depicted on a silver drachm coin from ancientHellenic colony Trapezus on the Black Sea, modern Trabzon, c. 350–325 BC, presented in theBritish Museum in London. The coin shows a bankers table (trapeza) laden with coins, a pun onthe name of the city. 7
  • 8. In fact, even today in Modern Greek the word Trapeza means both a table and a bank.Traditional banking activitiesBanks act as payment agents by conducting checking or current accounts for customers,paying cheques drawn by customers on the bank, and collecting cheques deposited tocustomers current accounts. Banks also enable customer payments via other paymentmethods such as telegraphic transfer, EFTPOS, and ATM.Banks borrow money by accepting funds deposited on current accounts, by accepting termdeposits, and by issuing debt securities such as banknotes and bonds. Banks lend money bymaking advances to customers on current accounts, by making installment loans, and byinvesting in marketable debt securities and other forms of money lending.Banks provide almost all payment services, and a bank account is considered indispensable bymost businesses, individuals and governments. Non-banks that provide payment services suchas remittance companies are not normally considered an adequate substitute for having a bankaccount.Banks borrow most funds from households and non-financial businesses, and lend most funds tohouseholds and non-financial businesses, but non-bank lenders provide a significant and in manycases adequate substitute for bank loans, and money market funds, cash management trusts andother non-bank financial institutions in many cases provide an adequate substitute to banks forlending savings to.Interest is one of the main source of bank earning.Apart from using your money to make more money by investing it... they can also lendto individuals about 10 times what they receive.i.e: If you deposit Rs10000 in the bank, the bank will be able to lend Rs10, 000 to Mr.Sharma who just came after you... and they will charge Mr. Sharma interest on the Rs.10,000... the bank does not need to have the money in cash to lend it out. In this case thebank is happy to pay you 5% interest on the Rs.1,000 (Rs. 50 in one year) because if theycharge Mr. Sharma 8% on the Rs 10,000 theyll make in 1 year Rs.800... Total profit forthe bank Rs.800-Rs 50 = Rs.750. 8
  • 9. A bank generates a profit from the differential between the level of interest it pays fordeposits and other sources of funds, and the level of interest it charges in its lendingactivities. This difference is referred to as the spread between the cost of funds and theloan interest rate. INTEREST A SOCIAL AND ECONOMICAL EVILIn modern secular economic systems interest plays a very important role. In fact, in theWestern world people cannot think of any economic system without interest. From atheoretical standpoint, interest has been a debatable subject among economic and politicaltheorists. Abu Saud defines interest as “the excess of money paid by the borrower tothe lender over and above the principal for the use of the lender’s liquid money overa certain period of time”. Economists have presented different interpretations ofinterest. Samuelson states that “Interest is the price of rental for the use of money”.Don Patinkin gives the following definition: “Interest is one of the forms of incomefrom property, the other forms being dividends, rent and profit”. However, J.M.Keynes did not define interest but mentioned the rate of interest as “The percentage ofexcess of a sum of units of money contracted for forward units of time over the spotor cash price of the sum thus contracted for forward delivery” 9
  • 10. However, socialist and a number of capitalist economists have questioned theseexplanations on both theoretical and technical grounds. They often stress the point thatmoney capital cannot be treated as capital goods on the same basis as productivefactors. It is pertinent to remark here that lending of money for interest was abhorredand, in most cases, prohibited by all the monotheistic religions.An eminent Western economist, Roy Harrod, regards the abolition of interest is the onlyway to avert a collapse of capitalism. Not only this, but he speaks with great admirationfor an interest-less society in his work on Economic Dynamics. Harrod clearlyrecognizes that, “It is not the profit itself, earned by services, by assiduity, byimagination, or by courage, but the continued interest accruing from the accumulationthat makes that profit taker eventually appear parasitical…” and he further states that aninterest-less society which will be a totally new kind of society” would be the correct andfinal answer to all that is justly advanced by the critics of capitalism.1,500 farmers commit mass suicide in IndiaOver 1,500 farmers in an Indian state committed suicide after being driven to debt bycrop failure.The agricultural state of Chattisgarh was hit by falling water levels."The water level has gone down below 250 feet here. It used to be at 40 feet a few yearsago," Shatrughan Sahu, a villager in one of the districts, told Down To Earth magazine"Most of the farmers here are indebted and only God can save the ones who do nothave a bore well." 10
  • 11. Mr Sahu lives in a district that recorded 206 farmer suicides last year. Policerecords for the district add that many deaths occur due to debt and economicdistress.In another village nearby, Beturam Sahu, who owned two acres of land was among thosewho committed suicide. His crop is yet to be harvested, but his son Lakhnu left to take upa job as a manual labourer.His family must repay a debt of 3000 and the crop this year is poor."The crop is so bad this year that we will not even be able to save any seeds," saidLakhnus friend Santosh. "There were no rains at all.""Thats why Lakhnu left even before harvesting the crop. There is nothing left to harvestin his land this time. He is worried how he will repay these loans."Bharatendu Prakash, from the Organic Farming Association of India, told the PressAssociation: "Farmers suicides are increasing due to a vicious circle created bymoney lenders. They lure farmers to take money but when the crops fail, they areleft with no option other than death."Mr Prakash added that the government ought to take up the cause of the poor farmers justas they fight for a strong economy."Development should be for all. The government blames us for being againstdevelopment. Forest area is depleting and dams are constructed without proper planning.All this contributes to dipping water levels. Farmers should be taken into considerationwhen planning policies," he said. ---INTEREST PROHIBITED IN ALL MAJOR RELIGION----- INTEREST PROHIBITED IN ISLAMThe word ―Riba‖ is used in the Holy Quran 8 times. In 30:39,4:161,3:130, 2:276,2:278 and 3times in 2:275. The Quran says:―Those who devour usury will not stand except as stand one whom the Evil one by his touch Hathdriven to madness. That is because they say: "Trade is like usury," but Allah hath permitted tradeand forbidden usury. Those who after receiving direction from their Lord, desist, shall bepardoned for the past; their case is for Allah (to judge); but those who repeat (The offence) are 11
  • 12. companions of the Fire: They will abide therein (for ever).‖ (Quran 2:275)―O ye who believe! Devour not usury, doubled and multiplied; but fear Allah. that ye may (really)prosper.‖ (Quran 3:130)―O ye who believe! Fear Allah, and give up what remains of your demand for usury, if ye areindeed believers. If ye do it not, take notice of war from Allah and His Messenger. But if ye turnback, ye shall have your capital sums: Deal not unjustly, and ye shall not be dealt with unjustly.‖(Quran 2:278-279)If you are dealing in interest. Please do not expect angels to come down with swords to wage awar against you. It is talking about the severity of the sin. For other sins like alcohol, gambling etc.the Quran says:―O ye who believe! Intoxicants and gambling, (dedication of) stones, and (divination by) arrows,are an abomination,- of Satans handwork: eschew such (abomination), that ye may prosper.‖(Quran 5:90)Here the Quran says that intoxicants and gambling are Satan‘s handiwork and abstain from it. Inthe case of Riba (Interest) the Quran does not only say that it‘s a sin but it says that Allah (SWT)and his messenger Muhammad (pbuh) will wage a war against. Showing how grave this sin reallyis. Prophet Muhammad (pbuh) said:Prophet Muhammad (pbuh) classified it among the seven major sins” Volume 8, Book 82,Number 840: Narrated Abu Huraira:The Prophet said, "Avoid the seven great destructive sins." They (the people!) asked, "OAllahs Apostle! What are they?" He said, "To join partners in worship with Allah; to practicesorcery; to kill the life which Allah has forbidden except for a just cause; to eat up usury (Riba),to eat up the property of an orphan; to give ones back to the enemy and freeing from the battle-field at the time of fighting and to accuse chaste women who never even think of anythingtouching chastity and are good believers."Some may argue that only the taking of interest is prohibited. But one Sahih Hadith says―· Hazrat Jabir r.a. has reported that the Messenger of Allah cursed the devourer of usury, itspayer, its scribe and its two witnesses. He also said that they were equal (in sin).‖ (Mishkat-ul-Masabih) INTEREST PROHIBITED IN BIBLE“Do not charge your brother interest, whether on money or food or anything else thatmay earn interest.” (Deuteronomy 23:19)“Do not take interest of any kind from him, but fear your God, so that yourcountryman may continue to live among you.” (Leviticus 25:36)“If you lend money to one of my people among you who is needy, do not be like amoneylender; charge him no interest” (Exodus 22:25)Righteous servant of God doesn’t take interest 12
  • 13. "Suppose there is a righteous man who does what is just and right. He does not eat at themountain shrines or look to the idols of the house of Israel. He does not defile hisneighbors wife or lie with a woman during her period. He does not oppress anyone, butreturns what he took in pledge for a loan. He does not commit robbery but gives his foodto the hungry and provides clothing for the naked. He does not lend at usury or takeexcessive interest. He withholds his hand from doing wrong and judges fairly betweenman and man. He follows my decrees and faithfully keeps my laws. That man isrighteous; he will surely live, declares the Sovereign LORD. (Ezekiel 18:5-9)But the violent one will take it "Suppose he has a violent son, who sheds blood or does any of these other things(though the father has done none of them): "He eats at the mountain shrines. He defileshis neighbors wife. He oppresses the poor and needy. He commits robbery. He does not return what he tookin pledge. He looks to the idols. He does detestable things. He lends at usury and takesexcessive interest. Will such a man live? He will not! Because he has done all thesedetestable things, he will surely be put to death and his blood will be on his own head”(Ezekiel 18:10-13)Jesus Christ came to fulfill the Law. He said:“Think not that I am come to destroy the law, or the prophets: I am not come to destroy,but to fulfill. For verily I say unto you, till heaven and earth pass, one jot or one tittleshall in no wise pass from the law, till all be fulfilled. Whosoever therefore shall breakone of these least commandments, and shall teach men so, he shall be called the least inthe kingdom of heaven: but whosoever shall do and teach them, the same shall be calledgreat in the kingdom of heaven. For I say unto you, that except your righteousness shallexceed the righteousness of the scribes and Pharisees, ye shall in no case enter into thekingdom of heaven.” (Mathew 5:17-20)The prohibition of usury was adopted as a major campaign by the earliest ChristianChurch, following on from Jesus expulsion of the money-lenders from the temple.The decrees of the Hebrew Bible were revived and a new reference to usury in the NewTestament was added. Based on the authority of those texts, the Catholic Church of the4th century AD banned the clergy from charging interest, a rule that was later extended inthe 5th century to the laity.In the 8th century, under Charlemagne, usury was declared a criminal offense. Theanti-usury movement gathered force in the late Middle Ages and reached its peak in 1311when Pope Clement V totally banned the practice and declared null and void allsecular law defending it.In spite of subsequent papal and legislative bans, loopholes in the law and contradictionsin the Churchs arguments began to appear. Soon, on the rising tide of commerce, the pro-usury movement began to grow. The rise of Protestantism and its pro-capitalist slantstrongly influenced change. However while both Luther and Calvin expressed 13
  • 14. reservations about the practice of usury, neither condemned it outright.Calvin, for example, cited seven situations in which interest was sinful. These werelargely ignored however and his position interpreted as a general sanctioning of charginginterest. As a result of these influences, around 1620, according to the theologian Ruston,usury passed from being an offense against public morality, which a Christiangovernment was expected to suppress, to being a matter of private conscience, and a newgeneration of Christian moralists redefined usury as excessive interest.Nevertheless, the ancient criticisms continue to pervade the Churchs modern thinking, assuggested by the viewpoint of the Church of Scotland (1988) when it released a report onthe ethics of investment and banking.We accept that the practice of charging interest for business and personal loans is not initself incompatible with Christian ethics. What is more difficult to determine is whetherthe interest imposed is just or excessive said the report.In the same vein, it is interesting to contrast the clear moral mandate expressed throughPope Leo XIIIs Rerum Novarum (634-644 AD) about ravenous usury as a demoncondemned by the Church but practized in a deceitful way by avaricious men, with PopeJohn Paul IIs encyclical Solicitude Rei Socialis (1987) which omits any explicit mentionof usury, except for a vague reference to recognizing the Third World debt crisis.This demon governs current global relations, condemning most of the worldpopulation to living under the sign of debt: i.e., each person born in Latin Americaowes already $1,600 in foreign debt; each individual being conceived in Sub-SaharanAfrica carries the burden of a $336 debt, for something that its ancestors have longago paid-off. In 1980 the Southern countries debt amounted to $567 billion; sincethen, they have paid $3,450 billion in interests and write-offs, six times the originalamount. In spite of this that debt had quadrupled by the year 2000 reaching $2,070billion. INTEREST PROHIBITED IN JUDAISMJudaisms criticisms of usury are rooted in several passages of the Old Testament in whichcharging interest is scorned, discouraged and prohibited. The Hebrew word for interest isneshekh, which means bite (though in Leviticus tarbit and marbit are also used), and it isbelieved to refer to the charging of often exorbitant interest (from the debtors perspective). 14
  • 15. In the Hebrew books of Exodus and Leviticus the ban is thought to be applied exclusivelyto loans to the poor and the sick, while in Deuteronomy, it extends to all loans, excludingtrade with foreigners. The word foreigner is interpreted in general as enemy and, armedwith this text, Jews employed usury as a weapon, as other peoples needs could betransformed into submission.Beyond these biblical roots, there are several Talmudic extensions of the bans on interest, knownas avak ribbit -literally the dust of interest, which is applied for example to certain types of sales,rent or work contracts. It is distinguished from the rubbit kezuzah, interest adjusted over aquantity or a rate agreed between the lender and borrower. The legal difference is that the latter,if the debtor pays the lender, is recoverable from the lender, while the former, once paid, is notrecoverable, though it is recognized that a contract sullied by the dust of interest may not befulfilled.In spite of the ban, this rule does not appear to have been observed in biblical times. In additionto the various references in the Old Testament to lenders who are rigidly exacting high interestrates, it can be seen in the Elephantine Papyrus (dating to the reign of Tuthmosis III) that amongthe Jews of Egypt in the 5th century BC it was the norm for interest to be charged for loans. Thissuggests that the violation of the ban was not seen as a criminal offense with a penal sanction,but as a moral transgression.This can also be partially explained by the change in economic conditions, beginning in theAmoraim period in Babylonia (200-500 AD), when the prohibition against interest was agreedwhen usury became incompatible with the communitys economic needs.At the same time, a standard way of legalizing interest was established, known as hetter iska.This referred to the permission to create partnerships, which has become so common that todayall transactions with interest are made openly according to Jewish law, simply adding to thecorresponding note or contract the words al-pi hetter iskah. INTEREST PROHIBITED IN HINDUISM & BHUDDAISMThe oldest references to usury are found in religious manuscripts of India, dating back to2000-1400 BC where the usurer is associated with any interest lender. In the Hindu Sutra(700-100 BC) as well as in the Buddhist Jatakas (600-400 BC) there are many references tothe payment of interest, along with expressions of disdain for the practice. 15
  • 16. Vasishtha, a prominent lawmaker of the era, drafted a law that banned the high casteBrahmans and Kshatryas from being usurers or money-lenders. In the second century AD,the term usury becomes relative, meaning that interest above the legal rate could not be charged;that would be a usurious loan. But usury in some form or other has continued to the present day,and although in principle it is condemned, the term usury refers only to exorbitant interest, ie wellabove socially accepted rates. The practice operates in most parts of the world. INTEREST PROHIBITED IN WESTERN PHILOSOPHYMany of the early Western philosophers including Plato, Aristotle, Cato, Cicero, Seneca andPlutarch were critics of usury. In the legal reforms of the Roman Republic (340 BC), usury andinterest were banned. However, in the final period of the Republic, the practice was common.Under Julius Caesar, a limit of 12 per cent was imposed due to the great number ofdebtors, and under Justinian it was set at a mean between 4 per cent and 8 per cent.In the Book, the FUTURE OF MONEY, Bernard lietar, he expertly highlights the intrinsic dangerof Interest and then mentions how Islam has admirably represented the last bastion of resistance.He illustrates how interest is direct cause of inflation, wealth imbalance contributing rich gettingricher and poor getting poorer. WHY INTEREST IS PROHIBITED IN DIVINE LAW?It is worth to present an example to start with the subject, a factual example from existing interestbased banking methodology that is valid and current, which can be well understood by a commonperson. One should consider the following facts before going through the example. The factsare: Only Banks create money. The created money is then supplied in to the economy only in the form of loan at some specified interest. There are no other institutions that create money other than banks. 16
  • 17. As all the banks are creating money and supplying in to the economy on interest and without anydoubt all of them are practicing the same technique, so let us consider there is only one bank inour example that creates some money and supply in to the peoples economy.Suppose Bank XYZ creates Rs.1, 00,000 and supplies it at an interest rate of 10% per annum toseveral entrepreneurs and governmental units active in the economy remember there is nomoney available in the economy from any other source. The bank has taken substantial collateralor guarantee as security of its money from each borrower. See in the following diagram - theborrower‘s intake loan and repayment liabilities at the end of the first year:It is very simple and clear that at the end of the first year, a combined sum of Rs.1,10,000 is dueon all borrowers to repay to the loaning bank.But the money available in the economy is only Rs.1, 00,000 as the bank is only supplier ofmoney, so from where the rest 10,000 would come that is the difference in the borrowers intakeand total repayment amount...... from NOWHERE. Yes, that is right from nowhere because thatmoney does not exist in the economy.Look at the scene, the bank is the only supplier of money, it creates and supplies 1,00,000 in theeconomy and that is the total money available in the economy, but as per loan agreements -these borrowers collectively have to pay back 110,000. How is that possible? There is no way.Dont you believe, it is 100% like this - no less. This is cheating and criminal foul play. So whatwill happen, at least one or more of these borrowers would default on their loan(s) and wouldloose their personal assets or belonging that they had put as security to the bank for therepayment. The money creator has designed a mechanism that would force few of the borrowerseach year to default so that bank could forfeit the security assets and gain wealth by foul play.This is an eye opening example for those who previously had no idea about the mechanism ofbanks as how they operate and cause artificial shortage (scarcity) of the money in the societies.This is happening every where in this world from USA to the smallest country on this beautifulplanet. This artificial scarcity of money is the root cause of peoples problems from hard strugglefor surviving to the loss of happiness from their lives.In a Riba (interest) based system, people are not aware of this foul play - borrowers think thatthey will manage to repay the principal plus Riba (interest) as they think it would be coming from 17
  • 18. some where else, but the fact is - every borrower would be in battle with others where someborrowers have to lose in order for others to win, some would fail to pay their loans in order forothers to get the sum they need to pay off the Riba (Interest). When seen in totality, the supplyside is always in deficit and the liability is always in excess due to Riba (interest), the totalcombined supply cannot discharge the liability.After going through the above real example, I believe, now we are close to find out why Riba wasdeclared Haram in all religion.Let us begin with the economic reasoning of WHY: 1. The availability of each produce is limited, the liability cannot exceed the availability limit. 2. In any transaction, if a liability of produce "in excess" of "the produce available" is created, that extra liability would be artificial because excess quantity of produce does not exist.This universal economic code applies to each and every type of produce; to further get in to theexplanation of the rule, let us now identify what represents "the produce", "the transaction", and"extra liability":The ProduceIn its general expression "the produce" is any thing available to human beings for their use orconsumption, but here specifically those produce that can be involved in a transaction, it is best totake historical standards of transactions which are based on produce like gold, silver, grains,currency etc. because throughout history all transactions are carried out in publicly acceptableproduce only. These produce have served the societies as "medium of exchange", so it is moreappropriate logically and historically to consider the produce as "the medium of exchange" whichis again a general expression and can accommodate any other commodity/produce that may beused in a transaction.The TransactionIn this universal economic principle, the transaction is based on a single produce and naturally itcan only be a transaction of loan or exchange and nothing else. Although donations/grants alsoinvolve only one produce but that is not a transaction because a transaction means exchange ofgood(s) and/or service(s) either on spot or in any specified time frame involving one or moretypes of produce.Extra LiabilityRiba (interest, usury) is that extra liability created in excess of the produce available and thatdoes not exist. Every liability is a demand in practice, the basic rule of economics known to everyone is that to maintain economic equilibrium (stability) in the society, the supply side should beequal to the demand, if the demand is more than the supply - a shortage will occur. Creating anextra liability means creating an extra demand without increasing equal supply, this will start anever ending mechanism of perpetually increasing the shortage of that produce in the society.Conclusion: 18
  • 19. Riba was prohibited just to prevent the creation of "extra liability/demand" because that isfake and "does not exist" physically, this artificial "extra liability/demand" creates scarcityof the produce in the society and unjustly accumulation of the produce in few hands. Riba(interest, usury) is a mechanism and dangerous weapon that has a power to get hold ofassets/properties of individuals, enterprises, and nations deceitfully. This is unfair and against thenature, so ALLAH (SWT) banned Riba (interest, usury) very strictly to stop this criminal action.A Just SystemThere is no doubt that a just system could only be designed by keeping the Islamic economiccode at the heart of the system. This would only be possible when there will be a political will inthe leadership. Muslim scholars and bankers have spent much time in designing many bankingprocedures and instruments according to Shariah that can expedite the transformation easily, butthe question remains for the central governing system controlling the economy, the system mayincorporate and accommodate the following: The money creation should be the responsibility of the state. The banks must invest only in equity investment. The discounting should be explored such that it should serve as the driving force for the banks and the capital. Riba (Interest) must be declared as crime in the society.Few examples of RibaTo demonstrate the devastating power in the mechanism of Riba and the ignorance on thesubject, following are few examples. 1. Suppose, if just One Gram of Gold (i.e., one millionth of a metric ton) was loaned at an interest rate of 2% p.a. at the time of first Hijri year (Islamic calender), then today (after 1422 Islamic years) the quantity of gold required to repay that loan would be 1,696,071.847 metric tons of gold, while the total gold reserve of the world known today (explored or unexplored) are less than 160,000 tons. 2. If a nation takes a loan of say US dollars one billion at an interest rate of 3% p.a., it would have to repay US dollars 4.3839 billion after fifty years. One can imagine the multiplying rate of Riba mechanism that had badly affected the economies of already weak nations. INTEREST CAUSES INFLATIONThe argument of inflation is often advocated to compensate for the loss of value‖ or the―depreciation in money‖, and therefore any consideration to offset this damage may well bejustified. This approach may find its way fast in conventional organism, and to incorporate suchcomputations may not be a problem in a mere profit driven interest based system rather it can belooked upon as another risk calculating element. However, it can‘t and shall not go uncheckedwithout proper evaluation for its Islamic permissibility; a viewpoint is required to be established off 19
  • 20. topic. Although, the same sense has traveled to many of Islamic minds as well except with aquestion mark, it equates to similar asking that an extra ―equivalent to inflation‖ if charged by thelender will be considered as ―Riba‖ or not? Here the problem is double, there is a well-knownconfusion on the subject of inflation in Western economies and when coupled with the prevailingconfusion on the subject of ―Riba‖ in Islamic World – it becomes horrendous!At least there is a common settled perception that inflation is some sort of phenomenon related tothe upward trend in prices, but there is no unanimous agreement on the definition or what causesinflation. A wide variety of somewhat segmented classifications is provided from different schoolsof thoughts and work groups, like:1. Demand Pull Inflation (Demand Supply Phenomenon)2. Cost Push Inflation (Due to increase in the cost of production/supply)3. Built-in Inflation (Result of past events experienced now)4. Hyperinflation (Inflation getting out of control), etc.You may find different variants of definition in English dictionaries, and few are generous enoughto accommodate even sentimental statement within definition like "in inflation everything getsmore valuable except money" but the acuity is matching all across. In dynamic societies /economies, when some happening or any phenomenon is observed influencing the economy orsociety then to keep the system ongoing, the management drive also institutes and enforcescontrolling mechanisms. Since the exact and agreed upon cause(s) of inflation are not identified,therefore the subject is also handled segment-wise to a certain extent. A proof for this partialhandling is the formation of different indexes like:1. Consumer Price Index (CPI)2. Producer Price Index (PPI)3. Employer Cost Index (ECI)4. Purchasing Power (PP), etc. etc.There are many drawbacks connected naturally to indicators thus established from these indexesmainly because of the reason that these indexes do not cover every aspect but a weightedaverage of select group and therefore can not be reputed ―as convincing as it demands‖ to dealwith the problem. In addition to the statistics and analysis based on selected groups, there is aninteresting circle that further deteriorates the credibility of these pointers, that is:1. Use previous Price, Cost, and Purchasing Power etc. as reference.2. Calculate Inflation from present Price, Cost and PP.3. Prepare Reflection for the next.4. Remember we are talking about inflation – the upward trend,It is common and easy to understand that demand of certain things go high during some specificperiod or time or event, say for example ―dates‖ are high-in-demand in the month of Ramadan,therefore prices are inflated. Shortage of products and commodities is certain in the times of warsthus prices are blown-up. What is difficult to understand is the situation where say, I am on myplace for long; my city is calm, negligible change in habitants, increase in demand if any is metwith the increase in supply, wages are not increased since last year, and lifestyle of the citypeople cannot change overnight. No reflective change in anything, no specific period or event isaround, but prices are increasing in a regular pattern, a BIG WHY? This big why is regularizedand justified with the contraption of ―Inflation‖.What inflation is? - Answer “7.2%”How calculated? - “from CPI which is …..”What causes inflation? - “may be blab bla bla!” 20
  • 21. Figures work simple is that, it works because mostly people are interested in figures, so even ifnobody knows ―what causes inflation‖ - it will not make a difference or just very little difference –at least the inflation figure is known, isn‘t it interesting?What causes Inflation?An adequate amount of literature on different explanations is there available on book-shelves andInternet; inflation is explained as a result of ―excess money supply‖, a result of ―paper money‖,an outcome of ―increase in demand‖, a burden derived from ―over expenditure of government inthe form of taxes‖ etc.Central banks seem more convinced with the cause of ―excess money supply‖ (or may bebecause it is their jurisdiction and they can control it easily), anyway what ever is the reason oftheir persuasive cause, the adjustment they normally do is to squeeze money supply byincreasing ―interest rates‖ to fight ―so-called inflation‖. The monetary contraction and expansionpolicies are well known styles of central banks to address inflation and deflation respectively.What are the results of all these efforts taken in the context of ―inflation‖? I don‘t know any butconfusion. The every time successful strategy worked again, i.e., if you can‘t answer or can‘t doanything about a problem – try to confuse. But the monkey (if you know the story) was notsucceeded in confusing the complainant by jumping from one tree to another (exerting efforts) inorder to solve the problem of plaintiff. There are people in the society not satisfied with efforts ormeans undertaken to tackle inflation issue and the projections of its causes.What causes inflation is still not answered to their satisfaction. Although, the mentioning of―interest‖ as a relative of ―inflation‖ is seen, but ―Riba or Interest‖ is not labeled as the main causeof producing inflation which in my view is the ―true story‖. How and why?“Riba or Interest” AS THE “Cause of Inflation”In order to explain how ―Riba or Interest‖ becomes the main cause of Inflation, it is mandatory tofurther elaborate my point of view about ―Riba‖ that revolves around the ―non-existence‖ of theextraliability created in a transaction.At a given time of transaction when a lender and a borrower are going to agree on interest basedloan contract, there is an owner of each penny of capital available in the economy. Is there acontract executed at that moment with similar time span in the economy to bring about the―change of ownership of capital‖ equivalent to the ―Riba or Interest‖ in favour of borrower?Because of the deficit he is in now due to the just concluded agreement. No need of such asimultaneous contract, might be argued in a case where the borrower already owns equivalent tothat extra he has committed in terms of ―Riba or Interest‖ and is able to discharge his total liability.Any problem now, YES! Still there is. Whatsoever is the case, the borrower owns that much ornot, his commitment or promise is reflected in accounting books of lender in ―receivable‖ columnand ―balance sheet projection with increase of profit‖. Is there any manifestation of the contract onthe part of borrower? Yes, of course there will be. The books of borrower will be adjusted for anincreased liability, the assets side will be re-evaluated to balance or to gain profit (profit is themotive every where, means and rules are subjective), a check on options available to theborrower to match the increased liability will sound only to adjust the saleable assets pricesupward. If ―Riba or Interest‖ was not there in the contract; absolutely there was no requirement toadjust accounting books, and therefore no forced increase in the prices of saleable assets(inventory). From this single case in point, one can expand the canvas to every type of financialcontract incorporating ―Riba or Interest‖, the ―receivable‖ of lender is always reflected asincreased liability on accounting books of the borrower (an industrialist, trader, service provider,individual etc.), accounting adjustment of that ―increased liability‖ is only possible by upward priceadjustment of products and services. It can happen at the start of the business, in midway or 21
  • 22. whenever ―Riba or Interest‖ is recorded in books. Here, the whole economy is run like this,lending is taking place on regular basis incorporating ―Riba or Interest‖, prices are increased witheach cycle of lending, there is a continuous trend of increase in prices, study CPI and otherbunch of indexes, regard it as empirical evidence but please don‘t call it a phenomenon of ―Ribaor Interest‖ but ―Inflation‖. It looks simple; true as well ―the root cause of inflation is thepractice of incorporating Riba or Interest in lending”. This is totally opposite to the belief (ormistaken belief) posed by central banks. When central banks adopt the policy of ―increasinginterest rates‖, it gives an impression that by increasing interest rates, the inflation is reduced orat least capped from further increase in it, you heard this and kept in mind, but you can‘t beconvinced because there is no logic told. How interest-free banking works The case of JAK By- Ana Carrie 22
  • 23. Can a bank operate successfully if it does not charge interest on its loans? The Swedish JAKMedlemsbank (Members‘ Bank) certainly does – it has been called the safest bank in Sweden.This account of how it does so is based on two visits to its headquarters in Skövde and numerousconversations with JAK‘s enthusiastic staff and members, both in Sweden and in Ireland. I amindebted to the staff of JAK for their hospitality and assistance, and to Feasta for its financialsupport.Savings PointsJAK‘s primary objective is to provide its members with interest-free loans. In order to accomplishthis, it must attract interest-free savings. JAK uses a system of ―Savings Points‖ in order tobalance saving and borrowing. Given the choice of borrowing without interest or savingwithout interest, most of us would gladly choose borrowing. While people are generally willing tosave temporary surpluses of money in current accounts that don‘t pay interest, few are willing orable to save more significant amounts over a long period of time with no compensation.JAK cannot, of course, lend money without having savings on deposit and so, using anImaginative system of Savings Points, each member who wishes to take out a loan must saveMoney first and, over a lifetime with JAK, every member will have saved roughly as much moneyand for the same period of time as they will have borrowed. You could almost imagine JAK asAllowing its members to borrow (interest-free) from their future selves.For a new JAK member, the first step towards an interest-free loan is to save and therebyearn Savings Points. These are calculated as the amount saved, multiplied by the numberof months for which it is saved, multiplied by a Savings Factor. This factor variesaccording to the type of savings account the member has selected and is lower (about 0.7)for a demand account from which savings can be withdrawn at any time. For example,assuming a Savings Factor of 0.9,we have1:€100 1 Month 0.9 = 90 Savings Points The Savings Factor varies with the type of depositaccount and is lowest for demand accounts where savings can be withdrawn at any time(about 0.7).Example 1: Either of these scenarios would earn identical Savings Points.After saving for a minimum of six months, a member may apply for a loan. In order to borrow €1for one month, one Savings Point must be redeemed. The amount borrowed and the time takento repay are entirely up to the member, provided that the appropriate Savings Points areavailable. For example, borrowing €90 (or €9,000) over 1 year uses as many savings points asborrowing €45 (or €4,500) with repayments spread over 2 years. 23
  • 24. Example 3: An alternative basic loan, borrowing half as much but repaying it over a longerperiod.In addition to a Basic Loan that uses Savings Points already earned, members may apply for anAdditional Loan using Savings Points that will be earned in the future. An ―Allocation Factor‖(currently 14) is multiplied by the member‘s current Savings Points to determine the number 24
  • 25. of points available for an Additional Loan. Each loan repayment includes a savings installment,and the payments are structured so that when the loan is fully repaid, all necessarySavings Points have been earned. A consequence of this is that upon full repayment of anAdditional Loan, the member has built up significant savings. Savings made during the course ofrepaying a loan are known as Post-Savings, while those that precede the loan are Pre-Savings.Once the loan has been repaid, the balance of the post-savings is available to the member to bewithdrawn or, as frequently happens, to be used as the start of saving for a new loan.Example 4: A Basic Loan with an Additional LoanThere is no interest charged on a loan, of course, but members must place 6% of the value of theloan on deposit for the duration of the loan, and additionally pay a loan fee to coveradministration costs. Members also pay 200 SEK (about €22) when they first join JAK and 200SEK per year as a membership fee. JAK is a virtual bank in the sense that it has nobranches and business cannot be transacted in person. A necessary and prudent decision sincethe membership of JAK is quite spread out over a large country, and also resulting in no biasagainst rural members who would have to travel much farther to their nearest branch. A result ofthis ―virtual‖ status is that JAK members must have an account with another bank with which toconduct their day-to-day financial affairs. Members transfer money into or out of their JAKbasic account via post giro, bank giro or Internet into their other accounts. With improvements intechnology and the changing financial infrastructure, JAK hopes in the near future tooffer direct deposit of pay cheques and credit/debit card facilities to its members. Forsome members, this might negate the need to bank elsewhere.Credit controlLike any bank, JAK must ensure that loans can and will be repaid. Unlike most banks, however,JAK‘s system of saving and borrowing has several unique features that combine to give it an 25
  • 26. enviably low default rate. A member applying for a loan is given a range ofoptions for the loan size and duration based upon their desired loan amount, desiredrepayments and available savings points. When they have made their selection, the loandepartment within JAK must assess the member‘s ability to repay the desired loan. Themember‘s income and expenses are evaluated with the assistance of computer software thatcalculates average living expenses for individuals and families based upon age and gender.Between 20 and 25 applications are processed per week, and 95% are approved. Most loans aresecured, either against property or with a personal guarantor. Loans for up to 37,000 SEK(about €4,000) with 2-5 years‘ duration can be unsecured, but these are limited to 5% of JAK‘sturnover and so surplus applications must be held in a queue until funds are available. Themost common reason for borrowing is to refinance a conventional bank loan obtained tobuy a house followed by purchasing a car and making home improvements.In general, people who can save regularly are good performers when it comes to loanrepayments. The JAK system where saving must precede borrowing is therefore ideally suited toattracting these regular savers. In addition, around half-way through repayment of a loanthere is a break-even point where the Post- Savings on deposit are equal to the balanceoutstanding on the loan and from this point forward the loan is fully secured by the member‘ssavings.Very few JAK loans end in default. Borrowers are decidedly involved ―members‖ as opposed todisinterested ―customers‖. Many feel quite strongly about the idea of interest-free bankingand this common bond goes a long way towards encouraging good behavior. Personalguarantors rarely need to be asked to make good on their guarantee.LiquidityAt the simplest level, a bank takes one person‘s savings and lends them to someone else.Ideological arguments aside, this presents some practical difficulties. Firstly, what if a saver wantstheir money back before the borrower has finished with it? Secondly, what if there are notenough or too many borrowers relative to savers? The first point is generally dealt with in thebanking system by having a reasonably large number of savers and making sure that enoughmoney is set aside to cope with those who, on any given day, want some of their money back.While individuals might withdraw their savings in a random manner, a large group of savers willtend to be stable and predictable. It is JAK‘s policy to keep a minimum of 20% ofpre-savings available in either a bank account or in government bonds, either of which can be 26
  • 27. made available almost immediately. Too much liquidity means that money is lying idle ratherthan being lent out to members, so it is not seen as desirable to have much more than 20% onreserve. Post-savings do not need to have a component on reserve since these can only bewithdrawn at specified times. JAK also encourages stability from its savers by offering a higherSavings Factor in long-term deposit accounts. JAK members can choose from 6, 12 and 24-month deposit accounts which represent the advance notice required to make a withdrawal. Withregard to the second point, JAK has a more difficult balancing act between saving and borrowingthan other banks, due to the fact that the two are intimately linked by Savings Points.Most people save with the intention of borrowing in the future. An excess of saving today couldindicate too much demand for borrowing next year.The Allocation Factor has a central role in the relationship between supply of savings anddemand for loans. In general, the JAK board sets the Allocation Factor to reflect the current levelof liquidity within the bank. The greater the pool of excess savings, the higher the AllocationFactor to encourage members to take out loans and reduce the excess. Unfortunately for JAK,the relationship between the Allocation Factor and the demand for loans is not as simple as this.In the short term, increasing the Allocation Factor can actually make things worse, as membersdecide to increase their Savings Points with a view to taking out a larger loan in the future.Excess demand for loans would be particularly problematic for JAK. Reducing the AllocationFactor would likely lead to an outcry from members who had made financial plans based on ahigher factor. The alternatives, however, would be to refuse more loans or to introduce a waitinglist. The dynamics of this saving/borrowing relationship are likely to be a constant challenge toJAK‘s management as the membership grows and the range of banking services offered by JAKexpands.JAK cultureA significant amount of JAK‘s energy is devoted to communicating with its 21,000-strongmembership. JAK is a co-operative, fully owned by its members. In addition to a quarterlynewsletter, 24 regional offices staffed by trainedvolunteers keep in touch with members through study groups and exhibitions. While JAK‘sprimary function is to provide interest-free banking, it is also viewed by the membership as avehicle for economic reform.A recent innovation in support of economic reform is the Local Enterprise Bank. Communitymembers save in a special JAK account and, rather than earning points themselves, their savingsare used to provide an interest-free loan for a local enterprise. Savings are fully guaranteed, somembers are not exposed to any financial risk. The first two projects to be funded in this way arean ecological slaughterhouse and a replica Viking village. It is an interesting experiment in localfinance for local projects, and so far has been very warmly received by localmedia and participants. While savers don‘t, of course, receive any interest on their savings, theybenefit both economically and otherwise from the improvements in their local economy andinfrastructure as a result of the projects.ConclusionsThe JAK Members‘ Bank is unique in the commitment it inspires from its volunteers and staff. Itprovides affordable and responsible finance, and enables its members to have a say in wheretheir money is invested. I have no doubt it will continue to be true to its purpose and values whileexploring new frontiers in ethical finance. 27
  • 28. Why interest-free banking mattersDoes it matter whether a bank charges interest or not? After all, every bank has to charge for itsservices or it won‘t stay in business. Interest is simply the way that banks calculate the chargethey make for the service they render when they approve a loan and for the risk they take on bydoing so. Why shouldn‘t the charge be based on the amount of money involved, the time forwhich it‘s being lent and the demand for money at the time? Doesn‘t that method of calculationseem fair? As Ana Carrie shows in her article, even the JAK Bank charges an arrangement feefor approving a loan and then an annual fee every year for as long as that loan is on its books. Ifthese charges were expressed as an interest rate, they would work out at about 3%. That seemscheap until you realize that JAK requires its borrowers to lend it the sum that they borrow for anequivalent length of time. This means that, while they are lending to the bank, customers loseroughly the same amount of interest that they would have paid, net of the 3% service charge, ifthe JAK had been an ordinary bank and had charged them interest when they were borrowing.So if the JAK system merely involves people losing on the swings what they gain on theroundabouts, why are the bank‘s members so enthusiastic about it? One reason is that somebelieve that the charging of interest sets up a growth compulsion in the economy and that, asperpetual economic growth is unsustainable; the development of a no-interest banking system isa key step towards building a sustainable economy. The roots of this type of thinking run back tothe time when gold was used as currency. Since gold did not increase itself, and very little wasbeing mined, where, people asked, was the extra bullion to come from to pay the interest whenboth principal and interest had to be handed over at the end of the year? Obviously, the borrowercould only obtain more gold if someone else had less, so lending money at interest meant thateither the borrower impoverished himself when he paid over the extra or he impoverishedsomeone else. And, as neither outcome was socially desirable, usury, as all forms of moneylending were called no matter how low the interest rate, stood morally condemned by both theRoman Catholic Church and by Islam.Even though we now use paper currencies, this source-of-interest problem has not gone away.Since almost all money in circulation is issued on loan, the money to cover interest payments canonly be obtained by borrowers if other borrowers have borrowed sufficiently more. Moreover, thenecessity to pay interest on these additional borrowings means that the economy needs toexpand if the proportion of world income which is paid over in interest to the lenders is not toincrease. But let‘s look at this argument a little more closely. How much is ‗sufficiently more‘? Notall the interest paid over to the banks gets withdrawn from the stock of money in circulation.Some of it is returned to the stock right away by being paid as interest to the people from whomthe banks themselves are borrowing money. Some returns by being paid to cover the banks‘operating costs, such as their wages bill. And the amount paid in dividends to the banks‘shareholders goes back into the stock too. So only the fraction of the interest paid that ends up asthe banks‘ retained earnings has to be borrowed back into the system. This is not a seriousproblem. If inflation was allowed to run at about 2.5% a year, that would be enough to allow theratio between the level of outstanding loans and national income to be held constant. So, if onehas a fairly relaxed attitude to inflation, the charging of interest is not a serious component of thegrowth compulsion. If the JAK bank made a surplus one year and increased its reserves, it wouldbe just as much a part of the problem as its commercial, interest charging, competitors.Other members of JAK have more sophisticated reasons for giving the bank their support. OscarKjellberg, the development director, is opposed to charging interest because it transfers wealthfrom the poor to the rich and from declining areas - often rural ones - to more prosperous parts.―That sort of transfer doesn‘t happen with JAK,‖ he says. ―People save with us because theyeither want to borrow interest-free themselves or because they want to assign the right to aninterest-free loan to a relative, a son or daughter, perhaps or to an organization they support. Thismeans that most money is lent out in the same area that it was collected, and, if it‘s not, it‘s onlyloaned in a place and for a purpose which the original saver has approved.‖ 28
  • 29. In other words, perhaps the most important reason for backing JAK-style interest-free banking isthat it limits a dangerous, destabilizing positive feedback built into the present economic system.The feedback occurs because prosperous parts of the world get more investment because betterreturns can be had from projects there, which makes them still more prosperous, while poorerareas have what capital they possess taken away because no good projects can be found. As aresult, the poorer areas fall further behind and people living in them are forced to leave to seekwork wherever investment is going on. They take up residence in the expanding areas and addtheir spending to its rising income flow, generating further investment possibilities. And so thecycle goes on. A major cause of the emigration of young people from rural Ireland used to be thattheir parents had allowed their savings to be invested away from home. A JAK bank would helpprevent a recurrence of that situation.The JAK bank is a good example of a flourishing cooperative - the lenders and the borrowers andthe owners of the bank are all the same people – engaged together in an independent enterprisewhich serves them all and accords with their beliefs. Although the services provided and thepurposes for which loans are made are still fairly limited, these are expanding as Ana Carriementions at the end of her article. JAK is one of thousands of small cooperative banks around theworld that confound the myth that financial services are best provided by the large capitalistinstitutions which dominate the mainstream financial services industry. 29
  • 30. Basic Differences between Islamic and Conventional BankingBefore we understanding the detailed differences between Islamic and conventionalbanking products and transactions, it is important to know these broad differences:-# Islamic banking only deals in “halal” products and services. Thus, all transactions mustbe SHARIAH COMPLIANT i.e. must be in accordance with the Islamic Jurisprudence.# Most Islamic Financing transaction is based on trading and deferred exchange contract,whereas conventional banking loan product is granted on the basis of debtor and creditorrelationship. In short, Islamic bank relationship is regarded as “Financier &Customer/Client” rather than “Lender & Borrower”. The only lender and borrowertransaction under Islamic banking is when the borrower (i.e. the Bank) grant interest freeloan under the principle of "Al-Qhad". Under this transaction, we expect the borrower torepay the loan at no extra charges. But if it is granted based on "Al-Qhadhul Hassan", it islent based on benevolent basis i.e. if the borrower cannot pay, we should not be expectedto demand for repayment.# The consideration of collateral to be looked upon separately. However, if thetransaction is based on "joint-venture" basis, there should not be any collateral;# In a default or termination situation, the Bank (or financier) normally demand theoutstanding sale price. Generally, the sale price is fixed and comprise "principal andprofits" predetermined upfront before a contract is signed.# compounding calculation i.e. to conventional practice of "interest upon interest"element is strictly prohibited under Islamic banking system.PRINCIPAL OF ISLAMIC BANKING 30
  • 31. Islamic banking has the same purpose as conventional banking except that it operates inaccordance with the rules of Shariah, known as Fiqh al-Muamalat (Islamic rules on transactions).The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of riba(usury). Common terms used in Islamic banking include profit sharing (Mudharabah),safekeeping (Wadiah), joint venture (Musharakah), cost plus (Murabahah), and leasing(Ijarah).In an Islamic mortgage transaction, instead of loaning the buyer money to purchase the item, abank might buy the item itself from the seller, and re-sell it to the buyer at a profit, while allowingthe buyer to pay the bank in installments. However, the fact that it is profit cannot be madeexplicit and therefore there are no additional penalties for late payment. In order to protect itselfagainst default, the bank asks for strict collateral. The goods or land is registered to the name ofthe buyer from the start of the transaction. This arrangement is called Murabaha. Anotherapproach is EIjara wa EIqtina, which is similar to real estate leasing. Islamic banks handle loansfor vehicles in a similar way (selling the vehicle at a higher-than-market price to the debtor andthen retaining ownership of the vehicle until the loan is paid).An innovative approach applied by some banks for home loans, called Musharaka al-Mutanaqisa,allows for a floating rate in the form of rental. The bank and borrower form a partnership entity,both providing capital at an agreed percentage to purchase the property. The partnership entitythen rents out the property to the borrower and charges rent. The bank and the borrower will thenshare the proceeds from this rent based on the current equity share of the partnership. At thesame time, the borrower in the partnership entity also buys the banks share of the property atagreed installments until the full equity is transferred to the borrower and the partnership isended. If default occurs, both the bank and the borrower receive a proportion of the proceedsfrom the sale of the property based on each partys current equity. This method allows for floatingrates according to the current market rate such as the BLR (base lending rate), especially in adual-banking system like in Malaysia.There are several other approaches used in business transactions. Islamic banks lend theirmoney to companies by issuing floating rate interest loans. The floating rate of interest is peggedto the companys individual rate of return. Thus the banks profit on the loan is equal to a certainpercentage of the companys profits. Once the principal amount of the loan is repaid, the profit-sharing arrangement is concluded. This practice is called Musharaka. Further, Mudaraba isventure capital funding of an entrepreneur who provides labor while financing is provided by thebank so that both profit and risk are shared. Such participatory arrangements between capital andlabor reflect the Islamic view that the borrower must not bear all the risk/cost of a failure, resultingin a balanced distribution of income and not allowing lender to monopolize the economy.And finally, Islamic banking is restricted to Islamically acceptable transactions, whichexclude those involving alcohol, pork, gambling, etc. Thus ethical investing is the onlyacceptable form of investment, and moral purchasing is encouraged.Islamic banks and banking institutions that offer Islamic banking products and services (IBSbanks) are required to establish a Shariah Supervisory Board (SSB) to advise them and to ensurethat the operations and activities of the bank comply with Shariah principles. On the other hand,there are also those who believe that no form of banking can ever comply with the Shariah.Malaysia, the National Shariah Advisory Council, which additionally set up at Bank NegaraMalaysia (BNM), advises BNM on the Shariah aspects of the operations of theseinstitutions and on their products and services. In Indonesia the Ulama Council serves asimilar purpose. 31
  • 32. A number of Shariah advisory firms (either standalone or subsidiaries of larger financialgroups) have now emerged to offer Shariah advisory services to the institutions offeringIslamic financial services. Issue of independence, impartiality and conflicts of interesthave also been recently voiced. ISLAMIC BANKING TERMINOLOGY1) Bai al-inah (sale and buy-back agreement)The financier sells an asset to the customer on a deferred-payment basis, and then theasset is immediately repurchased by the financier for cash at a discount. The buying backagreement allows the bank to assume ownership over the asset in order to protect againstdefault without explicitly charging interest in the event of late payments or insolvency.Some scholars believe that this is not compliant with Shariah principles.2) Bai bithaman ajil (deferred payment sale)This concept refers to the sale of goods on a deferred payment basis at a price, whichincludes a profit margin agreed to by both parties. This is similar to Murabahah, exceptthat the debtor makes only a single installment on the maturity date of the loan. By theapplication of a discount rate, an Islamic bank can collect the market rate of interest3) Bai muajjal (credit sale)Literally bai muajjal means a credit sale. Technically, it is a financing technique adoptedby Islamic banks that takes the form of murabaha muajjal. It is a contract in which thebank earns a profit margin on the purchase price and allows the buyer to pay the price ofthe commodity at a future date in a lump sum or in installments. It has to expresslymention cost of the commodity and the margin of profit is mutually agreed. The pricefixed for the commodity in such a transaction can be the same as the spot price or higheror lower than the spot price. (Deferred-payment sale)4) Mudarabah (profit sharing)Mudarabah is an arrangement or agreement between the bank, or a capital provider, andan entrepreneur, whereby the entrepreneur can mobilize the funds of the former for itsbusiness activity. The entrepreneur provides expertise, labor and management. Profitsmade are shared between the bank and the entrepreneur according to predetermined ratio.In case of loss, the bank loses the capital, while the entrepreneur loses his provision oflabor. It is this financial risk, according to the Shariah, that justifies the banks claim topart of the profit. The profit-sharing continues until the loan is repaid. The bank iscompensated for the time value of its money in the form of a floating rate that is peggedto the debtors profits. 32
  • 33. 5) Murabahah (cost plus)"Mudarabah" is a special kind of partnership where one partner gives money to anotherfor investing it in a commercial enterprise. The investment comes from the first partnerwho is called "rabb-ul-mal", while the management and work is an exclusiveresponsibility of the other, who is called "mudarib". This concept refers to the sale ofgoods at a price, which includes a profit margin agreed to by both parties. The purchaseand selling price, other costs, and the profit margin must be clearly stated at the time ofthe sale agreement. The bank is compensated for the time value of its money in the formof the profit margin. This is a fixed-income loan for the purchase of a real asset (such asreal estate or a vehicle), with a fixed rate of profit determined by the profit margin. Thebank 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 asa mortgage with the bank until the Murabaha is paid in full.This type of transaction is similar to rent-to-own arrangements for furniture or appliancesthat are very common in North American stores.6) MusawamahMusawamah is the negotiation of a selling price between two parties without reference bythe seller to either costs or asking price. While the seller may or may not have fullknowledge of the cost of the item being negotiated, they are under no obligation to revealthese costs as part of the negotiation process. This difference in obligation by the seller isthe key distinction between Murabaha and Musawamah with all other rules as describedin Murabaha remaining the same. Musawamah is the most common type of tradingnegotiation seen in Islamic commerce.7) Bai salamBai Salam means a contract in which advance payment is made for goods to be deliveredlater on. The seller undertakes to supply some specific goods to the buyer at a future datein exchange of an advance price fully paid at the time of contract. It is necessary that thequality of the commodity intended to be purchased is fully specified leaving noambiguity leading to dispute. The objects of this sale are goods and cannot be gold,silver, or currencies based on these metals. Barring this, Bai Salam covers almosteverything that is capable of being definitely described as to quantity, quality, andworkmanship.8) 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 orrenting over a fixed period, and the second contract is a Bai that triggers a sale orpurchase once the term of the Ijarah is complete. For example, in a car financing facility, 33
  • 34. a customer enters into the first contract and leases the car from the owner (bank) at anagreed amount over a specific period. When the lease period expires, the second contractcomes 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 residualvalue at the end of the term and the time value or profit margin for the money beinginvested in purchasing the product to be leased for the intended term. The combining ofthese three figures becomes the basis for the contract between the Bank and the client forthe initial lease contract.This type of transaction is similar to the contractum trinius, a legal maneuver used byEuropean bankers and merchants during the Middle Ages to sidestep the Churchsprohibition on interest bearing loans. In a contractum, two parties would enter into threeconcurrent and interrelated legal contracts, the net effect being the paying of a fee for theuse of money for the term of the loan. The use of concurrent interrelated contracts is alsoprohibited under Shariah Law.9) Ijarah-wal-iqtinaA contract under which an Islamic bank provides equipment, building, or other assets tothe client against an agreed rental together with a unilateral undertaking by the bank orthe client that at the end of the lease period, the ownership in the asset would betransferred to the lessee. The undertaking or the promise does not become an integral partof the lease contract to make it conditional. The rentals as well as the purchase price arefixed in such manner that the bank gets back its principal sum along with profit over theperiod of lease.10) Musharakah (joint venture)Musharakah is a relationship between two parties or more, of whom contribute capital toa business, and divide the net profit and loss pro rata. This is often used in investmentprojects, letters of credit, and the purchase or real estate or property. In the case of realestate 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 necessarilyrequired to do so. The profit is distributed among the partners in pre-agreed ratios, whilethe 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).11) 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 theamount borrowed. However, the debtor may, at his or her discretion, pay an extra amountbeyond the principal amount of the loan (without promising it) as a token of appreciationto 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 onlytype of loan that does not violate the prohibition on riba, since it is the one type of loanthat truly does not compensate the creditor for the time value of money. 34
  • 35. 12) Sukuk (Islamic bonds)Sukuk isthe Arabic name for a financial certificate but can be seen as an Islamicequivalent of bond. However, fixed-income, interest-bearing bonds are not permissible inIslam. Hence, Sukuk are securities that comply with the Islamic law (Shariah) and itsinvestment principles, which prohibit the charging or paying of interest. Financial assetsthat comply with the Islamic law can be classified in accordance with their tradability andnon-tradability in the secondary markets.13) Takaful (Islamic insurance)Takaful is an alternative form of cover that a Muslim can avail himself against the risk ofloss due to misfortunes. Takaful is based on the idea that what is uncertain with respect toan individual may cease to be uncertain with respect to a very large number of similarindividuals. Insurance by combining the risks of many people enables each individual toenjoy the advantage provided by the law of large numbers.14) Wadiah (safekeeping)In Wadiah, a bank is deemed as a keeper and trustee of funds. A person deposits funds inthe bank and the bank guarantees refund of the entire amount of the deposit, or any partof the outstanding amount, when the depositor demands it. The depositor, at the banksdiscretion, may be rewarded with Hibah as a form of appreciation for the use of funds bythe bank.Shariah SupervisorsThe Board of Directors to appoint a Shariah Supervisor, responsible for monitoring allthe Bank‟s transactional procedures and assuring Shariah compliance.Also the General Secretary of the Fatwa & Shariah Supervision Board, the ShariahSupervisor handles queries about the Bank‟s administration from staff members,shareholders, depositors and customers, liaises with the Shariah auditors and providesthem with guidance. He submits reports and suggestions to the Fatwa & ShariahSupervision Board and to the Chairman of the Board of Directors. The position also callsfor participation in the Bank‟s training programmes.Shariah Auditing 35
  • 36. The supervisory function forms a part of the Shariah Supervision procedures, its maintask being to check Shariah compliance under the guidance of the Shariah Supervisor.The auditors continuously review the Bank‟s transactional procedures to ensureadherence to the framework created by the Fatwa & Shariah Supervision Board. TheShariah auditors submit periodic reports to the Shariah Supervisor so as to monitor andmaintain Shariah compliance. Islamic equity fundsIslamic investment equity funds market is one of the fastest-growing sectors within the Islamicfinancial system. Currently, there are approximately 100 Islamic equity funds worldwide. Thetotal assets managed through these funds currently exceed US$5 billion and is growing by 12–15% per annum. With the continuous interest in the Islamic financial system, there are positivesigns that more funds will be launched. Some Western majors have just joined the fray or arethinking of launching similar Islamic equity products.Despite these successes, this market has seen a record of poor marketing as emphasis is onproducts and not on addressing the needs of investors. Over the last few years, quite a number offunds have closed down. Most of the funds tend to target high net worth individuals and corporateinstitutions, with minimum investments ranging from US$50,000 to as high as US$1 million.Target markets for Islamic funds vary; some cater for their local markets, e.g., Malaysia and Gulf-based investment funds. Others clearly target the Middle East and Gulf regions, neglecting localmarkets and have been accused of failing to serve Muslim communities.Since the launch of Islamic equity funds in the early 1990s, there has been the establishment ofcredible equity benchmarks by Dow Jones Islamic market index (Dow Jones Indexes pioneeredIslamic investment indexing in 1999) and the FTSE Global Islamic Index Series. The Website monitors the performance of Islamic equity funds and provide a comprehensivelist of the Islamic funds worldwide. 36
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  • 41. Why Islamic Banking Is Successful?- By Prof. Rodney WilsonThe collapse of leading Wall Street institutions, notably Lehman Brothers, and the subsequentglobal financial crisis and economic recession, are encouraging economists world-wide toconsider alternative financial solutions.Attention has been focused on Islamic banking and finance as an alternative model. Whatlessons can be learnt, and how resilient have Islamic banks been during the current crisis?Islamic Banking Principles And Sub-prime LendingThe religious teaching underpinning Islamic finance is concerned with justice in financial contractsto ensure that none of the parties is being exploited.Riba( interest or usury) is one source of exploitation, especially, as in the case of sub-primelending, the highest rates were charged to lower earners. Such discriminatory charging byconventional banks was justified as being a reflection of the risks involved.Those on lower incomes, with poorer prospects of finding new employment in the event ofredundancy, were less likely to be able to service their interest payments.Islamic housing finance involves risk sharing between the bank and the client, rather thantransferring all the risk to the latter. Under the most commonly used diminishing musharaka(partnership) contract, the bank and the client form a partnership, with the bank providing up to 90percent of the purchase price, and the client at least 10 percent.Over a period of usually 10 to 25 years, the client buys out the ownership share of thebank which makes its profit from the rent paid by the client for the share the bank owns.In the event of a rental or repayments default, the bank may advance the clients an interest-freeloan (qard hassan in Arabic) to enable them to continue their payments during the recession inanticipation that they will pay in full when the economy rebounds. The client retains their homerather than being faced with eviction— like the victims of the sub-prime crisis.Of course Islamic banks have to appraise credit risk, and indeed are more cautious about whothey should finance than conventional banks. The banks in the United States charged higharrangement fees for sub-prime borrowers which were used to pay bonuses for those signing upnew clients.As the mortgages were sold on to Freddie Mac and Fanny Mae, the arrangers were unconcernedthat the sub-prime borrowers might be unable to meet their financial obligations. Indeed, giftswere provided to entice the feckless to sign up, and the mortgages often exceeded the value ofthe property. The banks in other words became mere booking agents, with no long termcommitment to their clients. 41
  • 42. The Islamic Banking RecordIn contrast to conventional banks, no Islamic bank has failed and has needed governmentrecapitalization which ultimately becomes a burden on hard pressed taxpayers.All Islamic banks comply with the Basel II capital adequacy requirements and the IslamicFinancial Services Board (IFSB)- the body which advises regulators with respect to Islamicfinance- has produced detailed guidelines on compliance. The IFSB has an on-going relationshipwith the Bank for International Settlements-the institution which developed the Basel standards-and is certain to be consulted as Basel III guidelines are drafted for capital adequacy which arelikely to be implemented globally in the coming decade.The soundness of Islamic banks is accounted for by the fact that they use a classical bankingmodel, with financing derived from deposits, rather than being funded by borrowings fromwholesale markets. Consequently when the credit crunch came and borrowing from wholesalemarkets was halted, Islamic banks were not exposed. However, Islamic banks are not immunefrom the effects of the global recession, and the fall in oil prices will inevitably have a negativeimpact on 2008 results of Gulf-based Islamic banks. The situation will become clearer fromFebruary once the audited financial statements start to appear.Two Islamic housing financial institutions, Amlak and Tamweel are being merged, as both havefaced problems given their exposure to the Dubai property market.In Iran where all financial operations have been shariah-based since the Law on Usury FreeBanking was introduced in 1983, banks have been relatively insulated from the financial crisis,ironically because United States sanctions meant they could not deal with institutions such asLehman Brothers which were trying to place large amounts of toxic debt with Middle Easternbanks. The sanctions therefore proved to be a blessing in disguise for Iran— although the Islamicbanks there have been adversely affected recently by the fall in gas prices.Nevertheless being state owned, institutions such as Bank Melli, the largest Islamic bank in theworld, are well placed to ride out the global financial storm. With assets of over $50 billion, and2007 profits exceeding $540 million, it has more than adequate resources to cope.Islamic Financial StabilityIslamic banks enjoy a built-in stabilizer to help them cope with economic downturns, as instead ofpaying interest to depositors, those with investment mudaraba accounts share in the banksprofits. Thus, if profitability declines in an economic downturn, depositors receive lower returns,but if profits rise they enjoy higher returns.This profit sharing reduces risk for the banks and means they are less likely to become insolvent.However as the banks build up a profit equalization reserve, which can be used to finance pay-outs during difficult years, depositors benefit from some protection of their returns duringeconomic downturns.The last year has been difficult, if not disastrous, for equity investors, given the fall in stockmarket prices globally.Investors in equities screened for shariah compliance have also suffered, but less than theirconventional counterparts, because they have not invested in the shares of riba-based bankswhich have fared especially badly during the global financial turmoil. 42
  • 43. Investors seeking Shariah compliance have portfolios which are more heavily weighted in sectorssuch as healthcare or utilities where revenue streams are maintained even during cyclical down-turns.Prospects for Islamic FinanceIslamic banking provides a viable alternative to conventional banking and is less cycle prone. Thespread of Islamic finance into western markets demonstrates that it now being treated seriouslyby regulators and finance ministries.There are already five wholly Islamic banks in London, and the first Islamic bank will openin France in 2009. According to the conservative estimates of the Banker in October 2008,Islamic financial assets globally exceed $500 billion, a figure that could easily double overthe coming decade. The experience of Islamic banking in the United Kingdom has beenextremely positive. Islamic Bank of Britain has been operating as a retail bank for over fouryears, and has attracted over 40,000 customers. HSBC Amanah, the Islamic financesubsidiary of HSBC, has been operating for ten years in London, focusing mainly oninstitutional clients and business finance.Alburaq, the Islamic finance subsidiary of Arab Banking Corporation, has become themarket leader for shariah compliant home finance in the United Kingdom. None of theseinstitutions has been affected by the global financial crisis, and their resilience bodes wellfor the future.Sukuk Are Real AssetsIn addition to banking, Islamic sukuk security issuance has enormous potential. Unlikeconventional bonds and notes, sukuk are backed by real assets, which provides assurance toinvestors .Although global sukuk markets were adversely affected by the global recession in2008, longer term prospects look promising, with the United Kingdom authorities promotingLondon as an international centre for sukuk issuance to rival Bahrain, Dubai and Kuala Lumpur.The Malaysian ringgit sukuk market has been largely unaffected by the global turmoil in securitiesmarkets, and issuers such as the Saudi Arabia Basic Industries Corporation, one of the world‘slargest petrochemical producers, view sukuk as a desirable instruments to raise funding for plantexpansion. There can be no doubt that Islamic finance has an exciting future, and the quest for afinancial system based on moral values rather than greed and fear, is bound to enhance itsposition in the global system.Professor Rodney Wilson is the Director of Postgraduate Studies, School of Government andInternational Affairs of Durham University. Prof. Wislons research areas are Islamic economicsand finance, Middle Eastern political economy, and The political economy of oil and gas. Hewrote various books on Islamic economics. 43
  • 44. Islamic equity funds see rapid growth-----Daniel Stanton on Monday, 18 February 2008The Islamic equity funds industry has grown to around US$20 billion in assets undermanagement, according to research released on Monday.Failaka Advisors, a fund monitoring company, said that Islamic equity funds had grown rapidly inrecent years, driven by GCC investors.Tariq Al-Rifai, chairman of Failaka, said: "The size of this market has tripled over the past fiveyears."Funds investing in the GCC market represent more than half of the entire Islamic equity fundindustry. Saudi Arabian funds and fund managers dominate the industry, accounting for nearly 75funds out of around 300 Islamic equity funds worldwide. Bahrain has become the favoredcentre for fund registrations in the Gulf, with institutions such as Kuwaits Global InvestmentHouse and Saudi Arabias National Commercial Bank having established fund managementoperations there recently.Failaka reported that in 2007 the best performing Islamic equityfund managed in the GCC was Saudi British Banks Amanah GCC Equity fund, whichdelivered a return of 83.2%. 44
  • 45. Islamic banks going forward: challengesThe continuing rapid growth of demand for Islamic financial services is clearly goodnews for Islamic banks. At the same time, it also presents some challenges, as the banksneed to invest in upgrading their credit risk management capabilities in line with the morecomplex and larger projects into which they are entering.Despite the rapid growth, business models and products of Islamic banks are still ratherhomogeneous, while Shari‟ah compliance amplifies risks stemming from productconfiguration and process implementation. The success of Islamic banking in recent yearshas produced too many Islamic banks with the same business models. There is a lack of„bread and butter‟ lending, and the current excess liquidity has led to too muchcomplacency among Islamic banks.In addition, there is a large and diverse set of accounting standard differences acrossdifferent jurisdictions. The development and setting of simple standard legal contracts isnecessary in order to overcome the complexity and heterogeneity of current contracts.Furthermore, the deployment of IT systems that help monitor the fulfillments andvisibility of processes on an end-to-end basis are crucial to facilitate the continuousmonitoring of activities by Shari‟ah scholars while eliminating the possibilities of non-compliance, which in some cases might render transactions invalid.Liquidity risk management of Islamic banks is an important challenge and is constraineddue to limited availability of tradable Islamic money market instruments and weaksystemic liquidity infrastructure. At the moment, there is no Shari‟ah-compliant short-term Islamic money market (less than one week maturity) in local currency or in USdollars, and Islamic repo markets have not yet developed. Islamic money markets withlonger maturities, which are based on commodity murabaha transactions (mark-upfinancing), sometimes suffer from unreliable brokers with low creditworthiness. Islamicbanks also have a competitive disadvantage with conventional banks, as they deposittheir overnight money with their domestic central bank interest free. The lack of liquidityand viable alternatives, combined with the competitive disadvantage, hamper the localIslamic banks and can even create a liquidity crisis.Islamic banks going forward: solutions and opportunitiesBoth risk managers and regulators are working to address the above challenges. Toovercome the shortcomings of the Islamic money market, many investment banks arecurrently designing new complex products, compliant with Shari‟ah law. It remains to beseen whether these new solutions will obtain widespread Shari‟ah-compliant status in theIslamic finance community, and generate enough demand for a functional Islamic moneymarket to develop.The rapid developments are likely to continue. Financial institutions in countries such asBahrain, the UAE and Malaysia have been gearing up for more Shari‟ah-compliant 45
  • 46. financial instruments and structured finance – on both the asset and liability sides. At thesame time, the leading financial centers, such as London, New York and Singapore, aremaking significant progress in establishing the legal and prudential foundations toaccommodate Islamic finance side-by-side with the conventional financial system. Manyof the largest western banks, through their Islamic windows, have become active andsometimes leading players in financial innovation, through new Shari‟ah-compliantfinancial instruments that attempt to alleviate many of the current constraints such as aweak systemic liquidity infra-structure. More conventional banks are expected to offerIslamic products, enticed by enormous profit opportunities and also ample liquidity,especially across the Middle East.New product innovation is also driven by domestic banks‟ interest in risk diversification.With a large number of new Islamic banks across the Middle East and Asia especially,diversification of products enables banks to offer the right product mix to moresophisticated clients. A few banks are already active across different jurisdictions, andthis trend is certainly going to continue in the near future, possibly with someconsolidation.On the regulatory front, the Islamic Financial Services Board (IFSB), an internationalstandard-setting organization based in Malaysia, has moved ahead with its efforts aimedat fostering of the soundness and stability of the Islamic financial services industrythrough more standardized regulation. Globally accepted prudential standards have beenadopted by the IFSB that smoothly integrate Islamic finance with the conventionalfinancial system. For instance, the adoption of the IFSB standards (somewhat akin toBasel II), which take into account the specificities of Islamic finance, ensures a levelplaying field between Islamic and conventional banks.Many challenges still lie ahead, as is clear from the discussion above. However, theongoing improvements in banks‟ risk management techniques and prudential frameworksfor Shari‟ah-compliant banking give reasonable hope that the Islamic financial industry‟sgrowth will contribute positively to broader financial and economic stability. 46
  • 47. POSTSCRIPT ON THE CREDIT CRUNCH,2009Underlying this had been a rise in US interest rates between 2004 and 2005 from 1% to5.35%, resulting in high levels of default at the “sub-prime” end, which is to say, the high riskend of the housing market. Because mortgage lenders had sold on their debts via hedge funds toother financial institutions, the consequence of irresponsible lending spread contagiouslythrough banking systems, especially in the West, as house prices started to fall and the realestate asset value underpinning the loans became negative. When BNP Paribas told itsinvestors that they would not be able to draw money out of two of its funds owing to a ―completeevaporation of liquidity‖ it was the start of a domino effect, forcing governments to step in andavert potentially catastrophic runs on major banks.From the perspective of usury which we now revisit more than a decade after its first publicationin 1998, we find it instructive to reflect on how far such problems can be laid at the door of aninterest-based banking system. Full consideration of this is beyond our current scope, but in thispostscript we will confine ourselves to making three brief observations.First, the credit crunch was a consequence of the preceding credit bubble inevitably bursting. Incertain Western countries, including Britain and America, governments had deregulated financialagencies to an extent where irresponsible lending became normalized. For example, inBritain, through until 2008, it was easy for people to get mortgage loans on property of 120% ofthe property value with few questions asked. Property prices were rising sharply, the globaleconomy was booming, and traditional banking caution was thrown to the wind. People re-mortgaged their homes to pay off credit card debts that carried very high rates of interest, andwhich had been sold to them by aggressive marketing. People had started to believe that ever-rising house values and continuing economic good times would generate property values thatwould continuously outstrip their liabilities. Far from failing to dispel this notion, leading lendersexploited it. City staffs were rewarded with massive ―fat cat‖ bonuses based on the size andquantity of loans made. Concerns about their overall quality of lending portfolios were silencedthrough hedging – the selling on and spreading out of risk on speculatively buoyant markets.While everybody played the game and interest rates remained low the system appeared to beworking. It met investor expectations with high rewards. But as US interest rates rose in anecessary effort to counteract the economic knock-on effects of house price inflation, theconsequences of having bought into a usurious and greed-driven system started to hit home. Loan default rates reached the point of crisis. Those who were able to see it coming, mostlythe wealthy and well-advised who had a greater variety of financial options open to them, wereable to bail out in time. Those who had been caught with little option if they wanted to buy ahouse to live in were squashed – leaving many young families now struggling to pay off debts astheir house values fell into negative equity. As the media rightly observed, Wall Street‘s gains areMain Street‘s losses, with the negative externalities of financial speculation passed on to societyas a whole. 47
  • 48. We might learn from this that an economics that canonises greed, lays in storecatastrophic weaknesses that will eventually hit the poor hardest.Our second point is that globalisation, whilst creating massive new economic wealth fromderegulated trade, has reduced resilience in the world financial system. Fire walls betweendifferent countries‘ economies that were held in place by measures such as controls on foreigncurrency transactions substantially fell away in the years that followed the ―new right‖ economicsof Reagan and Thatcher. Enabled by computerised production planning and stock control, newnotions of just-in-time commercial supply systems profitably maximised economic efficiency. Butthere was a hidden cost. It also reduced the resilience that slack allows in highly interdependentchains of supply. Without slack, supply networks, like the socio-ecological systems on which theydepend, become brittle. They become prone to breaking rather than bending when placed understress. And for a monetarily based economic supply system, a bank running out of liquidity is likea car suddenly losing its oil. Devoid of lubrication the engine grinds to a sudden halt. That waswhy, in 2008, governments were left with no option but to bail out the banks.This loss of resilience is what distinguishes the current situation from the bank crashes of the1920s. Back then, society and especially its food production was less industrialized. People livedcloser to the land. Most essential services such as food production were local production for localconsumption. But today, essential chains of supply are long, often global, and therefore subject tointernational market and financial vagaries. A glimpse of the consequences of such dependencycan be seen from what happened in Britain in September 2000 when fuel tanker drivers went onstrike. Within five days, panic buying emptied some supermarket shelves and the media carriedsporadic reports of fighting at the checkouts. The Blair government, fearing civil unrest,capitulated. Applied to the situation in 2008, we might ask much more unrest might have brokenout if bank failure had resulted in the sudden loss of financial lubrication with its consequentimmediate knock-on effects?We might learn from this that the risks are too high for governments to wash their hands ofregulating modern economies. Unfettered free markets expose the very fabric of civil society tothe law of the jungle on a bad day. Overly deregulated markets can only be transient phenomena,like handing out free pizza. Because of their abstract nature based on confidence – the wordmeans ―faith together‖ – financial markets are all the more volatile. The brazenness by whichfinancial engineers or rather, marketers, tried to spread risk by creating derivative ―products‖driven ultimately by mortgage interest rates and their effect on property values reveal a massivecollapse of responsibility. That collapse happened because faith shifted from having direct equityconnection to tangible assets onto abstract financial connections that could be many timesremoved and diluted from the reality on the ground. Such derivatives had become ships offantasy. Devoid of anchors, they drifted fecklessly with no bearings on the landmarks of realityuntil the rocks struck.Our third observation is that many people ask whether the ―credit crunch‖ (the term soundsdisarmingly like a packet of breakfast cereal, with a free gift inside) signals the ―end of capitalism‖.On the contrary, we consider that it represents only a cyclical spasm in the process by whichcapitalism periodically restructures itself in a crash that most hurts the weak. The consequence ofjob losses and repossessions in the housing market are that the relatively disadvantaged, manynow saddled with negative equity, will be forced long term to work harder to pay off debts,including their share of the national debt that will manifest in tax rises. As such, the creditors –many from their offshore tax havens - retain and reconsolidate a grip that they would not havehad if their involvement in the process had been through risk-shared equity holdings, as with 48
  • 49. Islamic banking principles. These investors will, in future, be the people who find themselves in aposition to buy up repossessed (which is to say, bankrupt) housing stock, and thereby strengthentheir arm in future as rentiers to those who have lost out. The relatively poor will be forced to workyet harder on a treadmill that damages family life and with it, weakens the future fabric of society.Capitalism can be understood at many different levels, from honest trade and entrepreneurialismall the way to its advanced Anglo-American casino version. In the latter, the role of moneyundergoes a shift. It changes from its primary role as a means of recording and lubricatingexchanges of goods and services. It takes on second order abstract qualities of beingspeculative. Here money alone generates more money, and the principle of usury – defining it asthe lending of money at real positive rates of interest (i.e. rates greater than what is needed tocover inflation and risk) – is the inner wheel driving the system.Although we believe capitalism in one form or another is here to stay, the "credit crunch" may godown in history as the most serious challenge yet to financially speculative advancedcapitalism. Henceforth electorates and their governments should give more determinedconsideration to the oligarchic principle of allowing so much power and latitude to shareholdersand their financial analysts whose investment motivation is purely to ‗play the market‘.2009 will probably mark the point at which the pendulum starts to swing back to more carefullyand strongly regulated financial markets. As it turns out, this approach is entirely consistent withthe philosophy of the iconic economists Adam Smith (who was after all a „moralphilosopher‟) and John Maynard Keynes (who warned against the dangers of speculativeactivities). Ironically, these are often cited by neo-liberal market fundamentalists in support oftheir ideological deregulatory stance. Any of us who have knowingly participated in usury-relatedcasino economics share the responsibility for what has happened. Whilst neither of the currentwriters is a Moslem, we cannot help but be reminded of the Islamic hadith that states: ―The takerof usury and the giver of it and the writer of its papers and the witness to it, are equal incrime.” To put it in the language of other Abrahamic religions, we have worshipped at theshrine of Mammon, the god of wealth. Mammon has now transmogrified into Moloch – thefire-filled hollow stone god of the Hebrew Bible. Into his lap the children were reputedlysacrificed … and that, in the name of idolatrously seeking future economic prosperity.Through the lens of such metaphor the ―credit crunch‖ must, like the ―climate change crunch‖, beunderstood spiritually, or in terms of deep values. It is our consumer greed that has driven theproblems now faced. Whatever our religious background if any, the crises of present times can beseen as a spiritual, or a values-based wake-up call. As such, modernity may still have somethingto learn from the ancients.Alastair McIntosh & Wayne Visser-January 2009 49
  • 50. Islamic banking and recessionBy Mark Tutton, For CNNLONDON, England (CNN) -- With irresponsible banking practices taking the blame forbringing about the global economic crisis, there has been a surge of interest in Islamicfinance. Islamic finance is estimated to be worth $700 billion and has been growing by 15 to20 percent per year.Now, a slew of academic courses are springing up to meet the demand of those wanting to breakinto an expanding market. According to ratings agency Moodys, the global Islamic financesector is worth $700 billion and has the potential to be worth $4 trillion.Whats more, the ethical principles underpinning Islamic finance are seen by some as offering amore sustainable alternative to profit-oriented conventional banking. The result is that academicinstitutions are lining up to offer formal training in the area.” There is a huge demand forIslamic finance courses now, so large that its difficult to cope with," Professor HabibAhmed, Sharjah chair in the school of government and international affairs at DurhamUniversity, England, told CNN.Durham will launch a Masters degree in Islamic finance from October, becoming one of anumber of European institutions to offer Islamic finance programs.‖ Islamic finance has beengrowing by 15 to 20 percent per year for some time and there is a lot of interest at the moment.People are looking for alternatives after the economic crisis.""Islamic economists believe that if the principles of Islamic finance were followed the crisiswouldnt have happened. We are seeing a lot of non-Muslim countries, including the UK,France, Japan, Hong Kong and Singapore encouraging Islamic finance," he said. There aremany differences between Islamic and conventional banking practices. One fundamentaldifference is that Islamic banks do not charge interest. Rather than borrowers and lenders, thesystem is based on buyers and sellers."Conventional banking is biased to the seller. Islamic finance is trying to level the ethicsbetween the two parties," Aly Khorshid, an Islamic finance scholar who writes for IslamicBanking and Finance magazine, told CNN."People think the Islamic Banking system is basedon faith, but its based on justice. The system is based on justice for the two parties andhow you get to the justice is extracted from Islamic faith ," he said. 50
  • 51. Khorshid said that there are similarities between "ethical investment" schemes and Islamicfinance, in that the Islamic system does not allow investment that harms people or theenvironment. He credits the rapid growth of the Islamic finance sector on the success of "sukuk"-- Islamic bonds. In the West, banks including Lloyds TSB, HSBC, Deutsche Bankand Citibank all offer Islamic finance products, catering to a niche market ofMuslim borrowers.But while Islamic banks allow Muslims to take advantage of financial services that are consistentwith their religious beliefs, it is the ethics underpinning Islamic finance that are attracting theinterest of conventional finance institutions keen to learn lessons from the banking crisis.Although Islamic banks have suffered from the global repercussions of the economic downturn,they emerged largely unscathed from the initial banking meltdown that brought about thatfinancial turmoil.Ahmed told CNN that is because Islamic banks are not allowed to deal in mortgage-backedsecurities or credit-default swaps, two of the practices accused of helping bring about the bankingcrisis.Khorshid said that although its too early to say if Islamic finance has dealt with economicdownturn better than conventional finance, the Islamic system has many more layers of riskassessment and management, which could help protect it from the problems afflictingconventional banks.But the growth of Islamic finance has brought its own problems. Critics say some banks useIslamic finance to package what are essentially conventional products. "Islamic banks are alsodriven by the profit motive and sometimes that can dominate the ethics," Ahmed told CNN.While Europe is catching up with the demand for these banking products, the U.S. is laggingbehind. Ahmed says that regulatory and legal changes are needed for Islamic finance to grow inthe U.S., but he adds there are signs that Canada may become a North American center forIslamic finance. The lack of Islamic finance services in the U.S. is reflected in a relative lack ofdemand for Islamic finance courses, but in the UK there is the opposite problem.With students coming from Asia and the Middle East to get the qualifications that will helpthem take advantage of the Islamic finance boom, Ahmed says it is difficult for universitiesto find qualified teaching staff. "Most people with PhDs in Islamic finance are working inthe industry, making a lot of money," he told CNN.He added that Islamic finance products have the potential to appeal to the non-Muslimsmarket, pointing out that in Malaysia the majority of customers for Islamic banks arentMuslims.” If people look at the principles theyll see something beneficial in terms ofeconomics, rather than just religious reasons. Its a type of ethical finance that may beattractive to a lot of people." 51
  • 52. Feasibility of Islamic banking in IndiaCurrent status of Islamic Banking in IndiaIslamic banks in India do not function under banking regulations. They are licensedunder Non Banking Finance Companies Reserve Bank Directives 1997 RBI(Amendment) Act 1997, and operate on profit and loss based on Islamic principles. Allthe Islamic banks have to be compulsorily registered with RBI.Reasons for non implementation of Islamic Banking in IndiaIn the straitjacket world of Indian banking, something as fascinating as Islamic banking isa distant dream. Nonetheless, countless advocates of Islamic banking have been tryingtheir best over the years to propagate the concept. In furtherance of this propagation theReserve Bank of India (RBI) constituted a committee in 2007 to examine the issue butviewed that Islamic banking cannot be offered by banks in India as well as the overseasbranches of local banks under the present legal framework. Except a basic offering likecurrent account, almost no other banking product in India can be modified to meet theconditions of Islamic banking. As a genre of financial services, Islamic banking shuns thevery idea of interest rates, and rests on profit-sharing principles. Based on the Shariahlaw, it abhors the business of making money out of money, upholding the belief thatwealth is generated through actual trade and investment. The RBI has not put the reportin the public domain.While the final form of the report is not known, from the newspaper reports it can becollected that the members had pointed out how Indian banking laws come in the way ofvarious Islamic banking principles. These are as follows: 1. n Al Wadiah (for saving bank account): Section 21 of the Banking Regulation Act(BR Act) requires payment of interest on such deposits; thus, interest-free deposit and asimple charging of premium or Hiba is not permissible.2. Mudarabah (for term deposit or investment): Here again, Section 21 of the BR Actdisallows such products where the bank can invest the money in equity funds (in India, 52
  • 53. equity exposure is determined by a separate set of rules), and the client has completefreedom in the management.3. Mudarabah, Musharakah (for project finance and SME credit): Sections 5, 6 of theBR Act indicate the forms of business a banking company can undertake, and does notallow any kind of profit-sharing and partnership contract the basis of Islamic banking.4. Ijarah (for home finance) : As against Islamic banking where the banks owns theasset and hold the title, Section 9 of the BR Act prevents the bank from any sort ofimmovable property other than private use.5. Instinsa (leasing, buyback): Besides the usual curbs on acquiring immovableproperty, offering Islamic banking products many not are bankable due to stamp duty,central sales tax and state tax laws that will apply depending on the nature of the transfer.The BR Act even disallows an Indian bank from floating a subsidiary abroad to launchsuch products, or offering these through a special window. Thus, the upshot of thefindings is that such banking experiment is impossible without a new law or multipleamendments to the BR Act.Another important consideration is the tax procedures. While interest is a passiveincome, profit is defiantly an earned income which is treated differently. If principles ofIslamic banking are incorporated then how does it comply with the tax procedure is themoot question. Furthermore RBI cannot act as the lender to such banks because suchaccommodation by the monetary authority is also interest based. Islamic banks cannotinteract with conventional banks based on principles of interest.ConclusionThough it can be concluded that as of now RBI has stopped all the possibility of Islamicbanking in India (other than NBFCs), there are certain questions which remainunanswered. The RBI report has not been made available on the public domain like otherreports are definitely one question waiting to be answered. If the international banks haveestablished Islamic merged it with their object of profit making why can the same bedone in India also is not answered. Keeping in mind the flourishment of IslamicBanking all over the world and the Muslim population in India these are the questionswhich have to be answered immediately and with certainty. 53
  • 54. High potential for Islamic banking in IndiaPoints of Essence: India could be a significant market for Islamic banking institutions due to its large Muslim population. However it is still subject to a favorable change in regulatory environment and increased awareness among Muslims and India.NEW DELHI,: Given favorable regulatory conditions, India holds a promising growthopportunity for Islamic finance institutions, whose asset base globally is expected tomore than triple to $1 trillion by 2016, a study says.Islamic banking is already fast gaining prominence among the global financialinstitutions, especially in the backdrop of the banking sector woes impacting the marketslike the USA and UK and the concept has a huge potential market in India as well,according to market intelligence and data analysis services provider Grail Research.India could be a significant market for Islamic banking institutions, provided there is afavorable change in regulatory environment and increased awareness among Muslimsand India as a whole, said a report by Grail Research, part of US-based managementconsultancy Monitor Group.“You need to look no further than at the profitability of Saudi banks (the world’s highest)for reasons why Islamic finance will have strong interest globally as a growth engine forfinancial services,” Grail Research Founder and CEO Mr Colin Gounden said.As per the Indian census, India has one of the largest Muslim population in the world buta large portion of this has not been able to access the banking services because as perIslamic principles, giving or receiving interest is prohibited though money can be lent onprofit sharing or fee based model.“The size of the market will be very large as the Indian population is above 100 croreand Muslim population itself is about 15 crore and majority of them, in the name ofreligious faith, are looking for interest free banking and finance,” University of Calicutprofessor AI Rahmatullah said. Under the current regulations, which do not allow banksto keep deposits without paying interests or enter into profit sharing agreements withclients, it is not possible for commercial banks to offer Islamic banking services in India. 54
  • 55. To get a clear picture, let us analyze the position of Islamic banking in India on SWOT(Strength, Weakness, Opportunity and Threat) Scale. SWOT analysis will help us tologically examine the chances if this concept would flourish or flounder in India.STRENGTHIslamic Banking will unequivocally ameliorate the deplorable condition of the poor andmarginalized segments of society. Banking products which comply with Islamic law arebecoming increasingly popular, not only in the Gulf countries and far eastern states likeMalaysia, but also in other developed markets such as the United Kingdom. Reputedbanks like Standard Chartered, Citibank, HBSC are operating interest free windows inseveral West Asian countries, Europe and USA. There is a huge potential market in Indiafor Islamic banking products.Islamic banking helps the weaker and hapless section of the society through variousfinancial products. Islamic banking finances (through its Joint ventures, partnerships andleasing)are provided by investors or banks to the borrowers with a condition thatfinancial risk is to be borne by the investors, and other risks to be borne by the borrower.This helps even the indigent and vulnerable to get finance at a no risk and cost basis, butdefinitely requires other credits like strong business proposal, rational planning, skilledhands and specialized art to attract the financier. Better business proposals succeed infetching funds as opposed to the projects with comparatively poor propositions. Suchinclusive growth will aggrandize the Indian economy.The high powered Raghuram Rajan Committee draft Report as released on 7th April2008, strongly suggested interest-free banking as a part of recommendations made forfinancial sector reforms. The Committee postulates that interest free banking is anotherarea that falls broadly in the ambit of financial infrastructure. Faiths prohibit the use offinancial instruments that pay interest. The non-availability of interest-free bankingproducts (where the return to the investor is tied to the bearing of risk, in accordance withthe principles of that faith) results in some Indians, including those in the economicallydisadvantaged strata of society, not being able to access banking products and servicesdue to reasons of faith. This non-availability also denies India access to substantialsources of savings from other countries in the region. While interest-free banking isprovided in a limited manner through NBFCs and cooperatives, the Committeerecommends that measures be taken to permit the delivery of interest-free finance on alarger scale, including through the banking system. This is in consonance with theobjectives of inclusion and growth through innovation. The Committee believes that itwould be possible, through appropriate measures, to create a framework for suchproducts without any adverse systemic risk impact.WEAKNESS 55
  • 56. Indian banking laws do not explicitly prohibit Islamic banking but there are provisionsthat make Islamic banking almost an unviable option. The financial institutions in Indiacomprises of Banks and Non Banking Financial Institutions. Banks in India are governedthrough Banking Regulation Act 1949, Reserve Bank of India Act 1934, NegotiableInstruments Act 1881, and Co-operative Societies Act 1961.Certain provisions regarding this are mentioned below Section 5 (b) and 5 (c) of the Banking Regulation Act, 1949 prohibit the banks to invest on Profit Loss Sharing basis -the very basis of Islamic banking. Section 8 of the Banking Regulations Act (BR Act, 1949) reads, "No banking company shall directly or indirectly deal in buying or selling or bartering of goods…" Section 9 of the Banking Regulations Act prohibits bank to use any sort of immovable property apart from private use –this is against Ijarah for home finance Section 21 of the Banking Regulations Act requires payment of Interest which is against Shariah.As regards to partnership by Islamic banks in a firm, the bank has to make sure that themanager does not avoid his responsibilities or obtain other non-pecuniary benefits at theexpense of non-participating partners and ensure the veracity of the profit statements.Monitoring of data about firms in which Islamic bank invests would involve exorbitantcost. However, Islamic banks need to set up monitoring cell to keep them informed of theinternal function of their joint venture. The implication is that banks and entrepreneurhave to function very closely.OPPORTUNITYIndia with a 15% Muslim population, the highest in a non-Islamic countryand second highest in the world offers huge opportunities to exploit. The size of themarket will be very large as the Indian population is above 100 crore and Muslimpopulation itself is about 15 crore and majority of them, in the name of religious faith, arelooking for interest free banking and finance. It is pertinent to mention here that Islamicbanking is not meant for Muslims only but non Muslims may also avail the benefit of it.And it is feasible to have a parallel banking system based on Shariah along with aconventional one.Eleventh Five Year Plan envisages inclusive growth with development in all sectors ofeconomy. Islamic banking is an effective mechanism to subjugate the liquidity andinflation problems along with allowing inclusive growth. For real inclusive growth, wehave to ensure increase in income and employment status of workers in all segments.If Islamic banking is introduced, the inadequate labor capital ratio, for informal sectorworkers associated with agriculture and manufacturing industries could be resolvedthrough equity finance, which might be a revolution in our agriculture and unorganized 56
  • 57. sector. With improved labor capital ratio, our vulnerable workers associated withagriculture and unorganized sector might be able to compete effectively with the formalsector workers. Thus Islamic Banking may financially empower majority of Indianworkers.Islamic banking may induce our political leaders to substitute grants and subsidies withequity finance schemes through specialized financial institutions because equity financeallows access to credit without debts of borrowers. Equity Finance helps achieve self-reliability which never comes through grant and subsidies. Islamic banking should not bea religion based banking business, but could be profitably used to resolve our issuespertaining to economy.Moreover with introduction of Islamic banking, Indian government will certainly gaindiplomatic advantages to make financial dealings with Muslim dominated nationsespecially to attract trillion dollars of equity finance from the gulf countries. This is moreimportant after the fall of the titans like Lehman Brothers because it reflects the economicdownturn in the west and the need of alternative sources of FDI for the Indian economy.India needs to provide a congenial economic environment to attract the financialinducement from the Gulf region.Islamic scholars have defined market instruments in length and they have permitted withsome conditions to have investments in stock market .Certain broad criteria are: The companys activities should not include liquor, pork, hotel, casino, gambling, cinema, music, interest bearing financial institutions, conventional insurance companies, etc. The total interest bearing debt of the company at any point in time should remain below one third of its average market capitalization during the last twelve months. Its aggregate of account receivables should remain below 45% of total assets. If company has any interest bearing income it should not be more than 10% in any condition.THREATSIslamic banking could be a huge political issue. Certain parties might abhor the use of theword "Islamic" and could term it as anti-Indian. They might argue that the very conceptof Shariah banking would go against the secular fabric of our country. We are alreadyfacing problems pertaining to Muslim Personnel Law and trying to implement UniformCivil Code. Therefore, at this juncture, if we introduce Islamic banking in India, it willcreate more problems than solving the issue. Moreover, it may bring financial segregationin the economy. The compartmentalization of Shariah compliant and Non ShariahCompliant banking might be used by certain vested interest to communalize the finance 57
  • 58. sector in India. Such questionably sane but unquestionably dangerous trend must beprevented with full might.CONCLUSIONIslamic banking is at an incipient stage. The existing legal framework does not permitIslamic Banking. Only selective activities like equity investment is possible, while tradefinance aspects like taking title to goods is not possible. A lot of amendments need to becarried out in the prevalent legal set up. Appropriate models need to be selected andimplemented to suit societys diverse financial needs. Islamic Bank of Britain, Islamicbanks of Thailand, Singapore and USA may be glaring models for Indian bankers. Thereputed domestic and international banks along with the collaboration of RBI should beinvolved in the process of determining and implementing Islamic Banking products.The importance and relevance of Islamic banking in India in the context of "FinancialTsunami" that has taken place in recent times further enhances the need of Shariahbanking. Also the political parties need economic rationality to convince majority ofvoters that Islamic banking is not being introduced to please Muslim voters but togenuinely boost faster and inclusive growth for the Indian economy. Obnoxious politicsin the name of religion must be avoided. I personally believe to refer Islamic Banking asInterest Free Banking so that it could be looked through the broad economickaleidoscope and not a narrow religious prism.With only minor changes in their practices, Islamic banks can get rid of all theircumbersome and sometimes doubtful forms of financing and offer a clean and efficientinterest-free banking. Participatory financing is a unique feature of Islamic banking, andcan offer responsible financing to socially and economically relevant developmentprojects. This is an additional service that Islamic banks offer over and above thetraditional services provided by conventional commercial banks. Such a system will offeran effective banking system where Muslims in India may invest in pursuant to Islamicprinciples and the rest may have an alternative to interest bearing conventional banking.Both systems can co-exist. Let the people of the largest democracy decide democraticallywhich one they should bank upon. The young sapling of Islamic banking must benurtured by the Government so that the country may reap the benefit of its fruit in thecoming period. 58
  • 59. Salman Khurshid assurescooperation for Islamic BankingSubmitted on 15 June 2009 -By news deskNew Delhi: Salman Khurshid, Minister of State for Minority & Corporate Affairs,assured to cooperate in the future programmes related to Interest-free IslamicBanking. He expressed his opinion after his meeting with Mr. H Abdur Raqeeb,Convener of the National Committee on Islamic banking, today.Mr. Raqeeb, General Secretary of the Indian Centre for Islamic Finance (ICIF), metwith Mr. Khurshid to discuss about the feasibility of Interest-free Islamic Banking inIndia.“Islamic Banking will be beneficial to the Indian society, particularly for themarginalized and the minorities, in terms of microfinance. It will also be beneficial inmajor investments from the Gulf countries for massive infrastructural development as inthe case of the US $ 10 billion-project in the Economic Development Zone inMaharashtra,” said Mr. Raqeeb. Exploring the possibility, he urged that if London,Singapore, Tokyo and Hong Kong can become „the hub and house of Islamic Finance &Banking‟ then why not Mumbai and Kochi?The following reports and documents about Islamic Banking in India were submittedto Mr. Khurshid:1. RBI Working Group Report to examine financial instruments used in Islamic Banking.2. Report of the Dr. Raghuram Rajan Committee appointed by the Planning Commissionof India for Financial Sector Reforms –CFSR- submitted to the Prime Minister of India.3. Lovell‟s Document on Islamic Finance Regulations in Non-OIC Jurisdiction - incountries like Britain, Singapore, Japan, Hong Kong, etc.4. Financial Services Authority (FSA) Report on Islamic Finance in UK: Regulations andChallenges. 59
  • 60. 5. Feasibility of Islamic Investment Company, KSIDC - Kerala State IndustrialDevelopment Corporation- prepared by Ernst & Young.6. Journey of Islamic Banking in India Power Point Presentation: Efforts undertakentowards popularizing the concept of Islamic Banking among various segments andstakeholders of Indian society. Indias first Islamic bank to start in Kerala by 2010The first Islamic bank in the country with active involvement of the Keralagovernment is likely to start operations in Kochi by next year as the banks registrationformalities are currently being fulfilled on a war footing.The Kerala industries department is actively involved in the new initiative and a highlevel meeting held at Kozhikode on August 12 had approved a project report prepared byErnst & Young.Kerala State Industrial Development Corporation, which is the designated agency forthe formation of the bank, will have 11 per cent stake in the proposed bankingcompany.According to government officials in the know, it will be registered as a non-bankingfinance company in the beginning and later get transformed into a full-fledged Sharai‟ah-compliant bank. It is likely that the registration formalities will be completed in thecurrent year itself and the NBFC will become operational in 2010.The project proposes to raise an initial capital of Rs 500 crore (Rs 5 billion) fromleading non-resident Indians and Indian business houses. According to sources close tothe development, leading NRI businessmen such as Mohammed Ali, MA Yusuf Ali, CKMenon and other Kerala-based industrialists such as Azad Mooppan have shown keeninterest in the venture. 60
  • 61. Though an RBI study group had eariler rejected the concept of Islamic banking, it gotthe backing of the Raghuram Rajan Committee on banking reforms. Purely based onSharai’ah principles, the bank will avoid interest-based business activities.The proposed Kerala-based bank plans to invest funds in infrastructure projects, and twoareas, Bai al Salam and Instinsa, under Sharai‟ah have been identified for suchinvestments.The bank will invest all its funds in wealth generating investment avenues and willdistribute profit to its shareholders. The proposed Islamic bank will also set apart a socialfund, compulsory under Sharai‟ah principles and the Islamic banking concept, and willprovide interest-free loans to the Gulf returnees to set up business or small scale ventures.The concept is getting widespread support among the Muslim community of the state as alarge number of rich Muslims are strictly practicing Sharai‟ah principles in business.A major chunk of such persons do not have a bank account. A lot of discussion is alsogoing on whether investment in capital market is against Sharai‟ah principles. A sectionof the community believes that share trading is against the fundamentals of Islam. So theformation of an Islamic bank will be a relief to them.This concept is very popular in West Asia and in predominantly Muslim nations such asMalaysia and Indonesia. Leading international banks such as HSBC and Standard &Charted have exclusive Islamic banking windows.According to sources, the biggest challenge before the Kerala-based bank will be theformation of a Shariah Supervisory Board in order to monitor the activities of thebank. The board should include independent scholars on Shariah and bankingbusiness. 61
  • 62. AMU to begin new course on Islamic bankingThe Aligarh Muslim University (AMU) has decided to begin a course on IslamicBanking and Finance, the first such course in India. The “interest free banking course” isto be based upon the norms of Shariah (Islamic rules on transaction).A three-member committee has been formed under Dr Mohammad Nejatullah Siddiqi, aretired AMU professor of Economics and Islamic Studies. Besides holding experience ofteaching Islamic Finance in various countries including Saudi Arabia and Malaysia, hehas been a consultant to a Los Angeles-based private firm, American Islamic Finance.The Central Board of Secondary Education (CBSE) had recently asked the university tostart an undergraduate programme in marketing and finance.Vice-Chancellor of the university, Prof Abdul Aziz, told The Indian Express: “Indianbanking system is gradually becoming aware of the Islamic banking. Indian studentsshould be exposed to the topic that holds considerable potential. We hope to begin thecourse in the next academic session.”Islamic law prohibits interest on both loans and deposits, as both profit and risk areshared together by the borrower and the lender. As a result, the depositor, who does notbear risk in other banking systems, has to equally share the risk with the bank in Islamicbanking. Owner of the capital, however, is allowed to have a share in the surplus.Though there isnt any Islamic bank in India, there exist a few non-banking cooperativeslike Al Ameen Islamic Financial & Investment Corporation Ltd in Karnataka andMumbai-based Al-Barr Finance House Limited, which has branches in cities like Aligarhand Chennai. There are also some popular investment companies like Parsoli CorporationLtd that claim to invest money as per the Islamic laws.Experts feel that following a drift in US and European markets, India is seen as apotential place for the Islamic banking, which can also attract NRI investors. “Some ofthe top Indian companies are looking forward to launch Islamic financial products in thecountry,” said Dr Siddiqi.He said: “There lies a huge job opportunity in Islamic financing in India. Some privateinstitutions provide a few short-term courses, but the programme at the AMU will betotally different.” 62
  • 63. Delhi mulls Islamic bankingNew Delhi, December 06: The government is considering changing banking law tointroduce an interest-free Islamic banking system in the country, sources said.The Shariah prohibits the collection and payment of interest, so many Muslims nowavoid opening bank accounts or refuse to claim the interest, which goes to a suspendedaccount.Under the Islamic banking system, banks don’t pay interests on deposits; nor do theycharge interest on loans. The money deposited is used to finance projects on ownershipbasis. The depositors share in the profit or loss of the projects financed through theirdeposits instead of getting interest.For instance, in case of a housing loan, the bank buys the property and rents it out to theborrower for a specified period of time. The rent is calculated on the basis of the cost ofthe property plus a profit margin. After the lease term is over, the tenant gets ownershipof the property.Under the existing banking system, only current accounts comply with Islamic bankingsince these accounts don‟t give any interest.An Islamic bank, however, cannot invest the money just anywhere: the Shariahprohibits investment in businesses considered haram, such as those related to alcohol,pork or pornography.An Islamic banking system will benefit India’s 15 crore Muslims, and also theeconomy by helping unlock the huge sums that remain uninvested by the community.Islamic banking is currently not allowed under India‟s banking act, but it is allowedthrough the non-banking financial institution route.The Centre plans to amend the act, adding to it a chapter exclusively dealing with allaspects of Islamic banking, sources said. It‟s not clear if the amendment bill would betabled in the current session of Parliament. The sources said the government would forma Shariah Supervisory Board to monitor the functioning of the Islamic banking system.Finance minister Pranab Mukherjee has had discussions with the Reserve Bank ofIndia on the subject and obtained its approval, they said. 63
  • 64. Although an RBI study group had earlier rejected the concept of Islamic banking, theRaghuram Rajan Committee on banking reforms later gave a positive report on “interest-free banking”. The minority ministry too is understood to be in favour.There has been a strong demand for Islamic banking in India from various groups andeven the Gulf countries. The Muslim League has handed a memorandum to the PlanningCommission urging it to promote interest-free, profit-based banking.The concept is popular in West Asia and predominantly Muslim nations such as Malaysiaand Indonesia. Leading international banks such as HSBC and Standard Charteredhave exclusive Islamic banking windows.The Kerala Industrial Development Corporation recently launched an Islamic bankingcompany of sorts, which has been registered as a non-banking finance company and willbe transformed into a full-fledged Shariah-compliant bank once the banking regulationsallow it. 64
  • 65. AustraliaIslamic Investment Company, Melbourne.BahamasDar al Mal al Islami, NassauIslamic Investment Company Ltd, Nassau.Masraf Faisal Islamic Bank & Trust, Bahamas Ltd.BahrainAlbaraka Islamic Investment Bank, Manama.Bahrain Islamic Bank, Manama.Bahrain Islamic Investment Company, Manama.Islamic Investment Company of the Gulf.Masraf Faisal al Islami, Bahrain.DenmarkIslamic Bank International of Denmark, Copenhagen.GuineaIslamic Investment Company of Guinea, Conakry.Masraf Faisal al Islami of Guinea, Conakry.KuwaitAl Tukhaim International Exchange Company, Safat.Kuwait Finance House, Safat.LiberiaAfrican Arabian Islamic Bank, Monrovia.LiechtensteinArinco Arab Investment Company, Vaduz.Islamic Banking System Finance S.A. Vaduz.LuxembourgIslamic Finance House Universal Holding S.A.MalaysiaBank Islam Malaysia Berhad, Kuala Lumpur. 65
  • 66. Pilgrims Management and Fund Board, Kuala Lumpur.MauritaniaAlbaraka Islamic Bank, Mauritania.PhilippinesPhilippine Amanah Bank, Zamboanga.QatarIslamic Exchange and Investment Company, Doha.Qatar Islamic Bank.Saudi ArabiaAlbaraka Investment and Development Company, Jeddah.Islamic Development Bank, Jeddah.SenegalFaisal Islamic Bank of Senegal, Dakar.Islamic Investment Company of Senegal, Dakar.South AfricaJAAME Ltd, Durban.SudanBank al Baraka al Sudani, Khartoum.Faisal Islamic Bank of Sudan, Khartoum.Islamic Bank of Western Sudan, Khartoum.Islamic Cooperative Development Bank, Khartoum.Islamic Investment Company of Sudan, Khartoum.SwitzerlandDar al Mal al Islami, Geneva.Islamic Investment Company Ltd, Geneva.Shariah Investment Services, PIG, Geneva.ThailandArabian Thai Investment Company Ltd, Bangkok.TunisiaBank al Tamwil al Saudi al Tunisi.TurkeyAlbarakah Turkish Finance House, Istanbul.Faisal Finance Institution, Istanbul.U.K. 66
  • 67. Albarakah International Ltd, London.Albaraka Investment Co. Ltd, London.Al Rajhi Company for Islamic Investment Ltd, London.Islamic Finance House Public Ltd Co., London.WEBSITES         www.thestatesman.netMAGZINE:  Islam, Muslim and WorldBOOKS:  Muhammad Nejatullah Siddiqi (2004), Riba, Bank Interest, and The Rationale of Its Prohibition  Muhammad Nejatullah Siddiqi Banking Without Interest 67
  • 68. 68