ISLAMIC BANKING

Introduction Modern banking system was introduced into the Muslim countries at a time when they were politically and economically at low ebb, in the late 19th century. The main banks in the home countries of the imperial powers established local branches in the capitals of the subject countries and they catered mainly to the import export requirements of the foreign businesses. The banks were generally confined to the capital cities and the local population remained largely untouched by the banking system. The local trading community avoided the foreign banks both for nationalistic as well as religious reasons. However, as time went on it became difficult to engage in trade and other activities without making use of commercial banks. Even then many confined their involvement to transaction activities such as current accounts and money transfers. Borrowing from the banks and depositing their savings with the bank were strictly avoided in order to keep away from dealing in interest which is prohibited by religion. With the passage of time, however, and other socio-economic forces demanding more involvement in national economic and financial activities, avoiding the interaction with the banks became impossible. Local banks were established on the same lines as the interest-based foreign banks for want of another system and they began to expand within the country bringing the banking system to more local people. As countries became independent the need to engage in banking activities became unavoidable and urgent. Governments, businesses and individuals began to transact business with the banks, with or without liking it. This state of affairs drew the attention and concern of Muslim intellectuals. The story of interest-free or Islamic banking begins here. In the following paragraphs we will trace this story to date and examine how far and how successfully their concerns have been addressed.

Definition Islamic banking refers to a system of banking or banking activity that is consistent with the principles of Islamic law (Sharia) and its practical application through the development of Islamic economics. Sharia prohibits the payment of fees for the renting of money (Riba, usury) for specific terms, as well as investing in businesses that provide goods or services considered contrary to its principles (Haraam, forbidden). While these principles were used as the basis for a flourishing economy in earlier times, it is only in the late 20th century that a number of Islamic banks were formed to apply these principles to private or semi-private commercial institutions within the Muslim community.

Riba
The definition of riba in classical Islamic jurisprudence was "surplus value without counterpart." or "to ensure equivalency in real value" and that "numerical value was immaterial." During this period, gold and silver currencies were the benchmark metals that defined the value of all other materials being traded. Applying interest to the benchmark itself (Ex natura sua) made no logical sense as its value remained constant relative to all other materials: these metals could be added to but not created (from nothing). Applying interest was acceptable under some circumstances. Currencies that were based on guarantees by a government to honor the stated value [fiat money] or based on other materials such as paper or base metals were allowed to have interest applied to them [9] When base metal currencies were first introduced in the Islamic world, no jurist ever thought that "paying a debt in a higher number of units of this fiat money was riba" as they were concerned with the real value of money (determined by weight only) rather than the numerical value. For example, it was acceptable for a loan of 1000 gold dinars to be paid back as 1050 dinars of equal aggregate weight (i.e., the value in terms of weight had to be same because all makes of coins did not carry exactly similar weight).

Historical Development
It seems that the history of Islamic banking could be divided into two parts. The earliest references to the organization of banking on the basis of profit sharing rather than interest (Fiqh al-Muamalat-the fundamental principal of Islamic Banking) can be traced to the late forties. However In the next two decades it attracted more attention, partly because of the political interest that it created in Pakistan and partly because of the migration of Muslims to the western countries. The Islamic Development Bank, an inter-governmental bank established in 1975, was born of this process, being the first bank incorporating the principles of shariah banking. The first private interest-free bank, the Dubai Islamic Bank, was also set up in 1975 by a group of Muslim businessmen from several countries. Two more private banks were founded in 1977 under the name of Faisal Islamic Bank in Egypt and the Sudan. In the same year the Kuwaiti government set up the Kuwait Finance House. In the ten years since the establishment of the first private commercial bank in Dubai, more than 50 interest-free banks have come into being. Though quite a few of them are in Muslim countries, there are now spreading in other countries as well like in Denmark, Luxembourg, Switzerland and the UK. In most countries the establishment of interest-free banking has been by private initiative (mostly by migrant Muslims). In Iran and Pakistan, however, it was by government initiative and covered all banks in the country.

Status of Islamic Banking

When the concept of Islamic banking with its ethical values was propagated, financial circles the world over treated it as a utopian dream. Having lived for centuries under the valueless capitalist economic system, they asked what ethics had to do with finance? Attitudes are changing gradually and in the last few years' value neutral conventional banking has begun to trouble the conscience of an increasing number of people. There is a reluctance to hand over the funds to banks and financial institutions that invest in companies engaged in unethical and socially harmful activities. The emerging Islamic banking scene has succeeded in achieving general acceptance. Today, Islamic banking is estimated to be managing funds to the tune of US$ 200 billion. Its clientele are not confined to Muslim countries but are spread over Europe, United States of America and the Far East. Islamic banking continues to grow at a rapid pace because of its valueorientated ethos that enables it to draw finances from both Muslims and non-Muslims alike. Islamic bankers, keeping pace with sophisticated techniques and latest developments have evolved investment instruments that are not only profitable but are also ethically motivated. Today, more than two hundred and fifty Islamic financial institutions are operating world-wide. The countries where Islamic financial institutions are functioning include: Albania, Algeria, Australia, Bahamas, Bahrain, Bangladesh, British Virgin Islands, Brunei, Canada, Cayman Islands, North Cyprus, Djibouti, Egypt, France, Gambia, Germany, Guinea, India, Indonesia, Iran, Iraq, Italy, Ivory Coast, Jordan, Kazakhstan, Kuwait, Lebanon, Luxembourg, Malaysia, Mauritania, Morocco, The Netherlands, Niger, Nigeria, Oman, Pakistan, Palestine, Philippines, Qatar, Russia, Saudi Arabia, Senegal, South Africa, Sri Lanka, Sudan, Switzerland, Tunisia, Turkey, Trinidad & Tobago, United Arab Emirates (Abu Dhabi, Dubai, Sharja), United Kingdom, United States, Yemen

Feasibility of Islamic banking in India

Current status of Islamic Banking in India Islamic banks in India do not function under banking regulations. They are licensed under Non Banking Finance Companies Reserve Bank Directives 1997 RBI (Amendment) Act 1997, and operate on profit and loss based on Islamic principles. All the Islamic banks have to be compulsorily registered with RBI. Reasons for non implementation of Islamic Banking in India In the straitjacket world of Indian banking, something as fascinating as Islamic banking is a distant dream. Nonetheless, countless advocates of Islamic banking have been trying their best over the years to propagate the concept. In furtherance of this propagation the Reserve Bank of India (RBI) constituted a committee in 2007 to examine the issue but viewed that Islamic banking cannot be offered by banks in India as well as the overseas branches of local banks under the present legal framework. Except a basic offering like current account, almost no other banking product in India can be modified to meet the conditions of Islamic banking. As a genre of financial services, Islamic banking shuns the very idea of interest rates, and rests on profit-sharing principles. Based on the Shariah law, it abhors the business of making money out of money, upholding the belief that wealth is generated through actual trade and investment. The RBI has not put the report in the public domain. While the final form of the report is not known, from the newspaper reports it can be collected that the members had pointed out how Indian banking laws come in the way of various Islamic banking principles. These are as follows:
1.

An 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 a simple charging of premium or Hiba is not permissible.

2. Mudarabah (for term deposit or investment): Here again, Section 21 of the BR Act disallows such products where the bank can invest the money in equity funds (in India, equity exposure is determined by a separate set of rules), and the client has complete freedom in the management. 3. Mudarabah, Musharakah (for project finance and SME credit): Sections 5, 6 of the BR Act indicate the forms of business a banking company

can undertake, and does not allow 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 the asset and hold the title, Section 9 of the BR Act prevents the bank from any sort of immovable property other than private use. 5. Istisna (leasing, buyback): Besides the usual curbs on acquiring immovable property, 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 launch such products, or offering these through a special window. Thus, the upshot of the findings is that such banking experiment is impossible without a new law or multiple amendments to the BR Act. Another important consideration is the tax procedures. While interest is a passive income, profit is defiantly an earned income which is treated differently. If principles of Islamic banking are incorporated then how does it comply with the tax procedure is the moot question. Furthermore RBI cannot act as the lender to such banks because such accommodation by the monetary authority is also interest based. Islamic banks cannot interact with conventional banks based on principles of interest.

Why Islamic Banking will fall in India

Islam prohibits usury instructs all its followers to stay away from taking or giving any form of interest. The whole idea behind prohibiting interest is to ensure that the borrower does not get taxed or punished. Murabaha is a typical Islamic banking product, as far as Shariahcompliance goes. Murabaha involves the bank purchasing a commodity at the market-value and then selling it to customer at a higher price than the market-value. Instead of interest in a traditional loan, the bank makes a profit with the difference of the purchase value. Islamic Banking has had its share of success in Arab nations, with many banks opening an Islamic branch and some even starting their own Islamic bank. The Middle East Bank in Dubai recently underwent a conversion to Emirates Islamic Bank under the Emirates Banking Group. Its being both adopted and accepted. The Indian government has done a decent job of separating the religion from an average Indians daily life, and most Muslims are already accustomed to getting through their day with their own adjustments as

far as the faith is concerned. So, the first challenge would be to get the Muslim population of India to cross over to Shariah-compliant banking product, and they would have to cite the teachings from Islams core to bring about the challenge.

Islamic Banking and Banking for Muslim in India

Many Muslims invest in mutual funds, shares and traditional non-Shariah compliant banking products. Most Muslims in India who would go on to bank tend to think with a secular starting point. The reality is a little more complex. There are Indian Muslims who have no compunctions about dealing with debt and interest is valid. Other Muslim customers who had a more orthodox approach deals with the prohibition on interest and insurance in a variety of ways, including: Not investing in Mutual funds with a debt component. Donating the interest on their salary savings account to charity. Using a zero-interest current account instead of a saving account.

Muslims who were so orthodox, that they did not utilize banking services at all. The size of that market is anybodys guess. It would be best if existing retails banks offer Islamic products within their current scheme and carry out their ledger-separation, overlooked be a Shariah authority, who can certify that the profit is indeed separated. Existing retail banks are in fact anxious to do exactly this. Malaysia and the UAE is the laboratory where domestic and foreign banks are concurrently running Shariah and non-Shariah compliant products. HSBCs Islamic mortgage in Malaysia has apparently been quite success, and Standard Chartered has recently launched a Shariah-compliant credit card in the UAE.

Interest-free banking as an idea

Interest-free banking seems to be of very recent origin. The earliest references to the reorganization of banking on the basis of profit sharing

rather than interest are found in Anwar Qureshi (1946), Naiem Siddiqi (1948) and Mahmud Ahmad (1952) in the late forties, followed by a more elaborate exposition by Mawdudi in 1950 (1961). Muhammad Hamidullahs 1944, 1955, 1957 and 1962 writings too should be included in this category. They have all recognized the need for commercial banks and the evil of interest in that enterprise, and have proposed a banking system based on the concept of Mudarabha - profit and loss sharing.

Islamic banking in non-Muslim countries

The modern commercial banking system in nearly all countries of the world is mainly evolved from and modelled on the practices in Europe, especially that in the United Kingdom. The philosophical roots of this system revolve around the basic principles of capital certainty for depositors and certainty as to the rate of return on deposits. In order to enforce these principles for the sake of the depositors and to ensure the smooth functioning of the banking system Central Banks have been vested with powers of supervision and control. All banks have to submit to the Central Bank rules. Islamic banks which wish to operate in non-Muslim countries have some difficulties in complying with these rules. We will examine below the salient features.

Loans with a service charge

All the problems of the Islamic banks arise from their need to their assets under the PLS scheme. A simple solution does, already exist in the current theories of Islamic banking. It need pointed out and acted upon. We will examine the provisions in the Pakistani and the Siddiqi models. acquire in fact, only be Iranian,

All three models provide for loans with a service charge. Though the specific rules are not identical, the principle is the same. We suggest that the funds in the deposit accounts (current and savings) be used to grant loans (short- and long-term) with a service charge. By doing this the Islamic banks will be able to provide all the loan facilities that conventional banks provide while giving capital guarantee for depositors and earning an income for themselves.

The Negative Area Trap Its an open secret that when it comes to retail lending, Muslims find it difficult to get credit cards or personal loans.

This difficulty arises not because of actual negative scoring for Muslims, but because the neighbourhoods which are classified as negative, nolending areas, are usually ones which have high Muslim or Dalit populations. Why does the credit policy fail Muslims in India? There are three possible reasons: 1. A complete mismatch between the global office and the country office. Everyone in the country top management is conspiring against Muslims. Unlikely, but possible. What makes it more unlikely is that this would be a conspiracy perpetrated by the top management of all banks in the country, who all have the same negative areas. 2. Plain laziness. The list of negative areas was drawn up a long time ago by the first bank to do retail lending, and then copied by all other banks, none of whom bothered to test it against actual experience. This is possible. 3. Negative areas are drawn up by banks in consultation with collections agencies. Collections agencies are not willing to work in ghettoised areas, because the people here, who are creditworthy enough to borrow, are also probably politically well-connected. If they default, and a collection effort is made, it can be responded to with violence with impunity.

So, at the end of this, where are we?

1. Islamic banking makes Muslim customers feel good. So banks could adopt it as a differentiating strategy. This makes more sense in countries like the UAE and Malaysia where there are many high net worth Muslim individuals than in India. But there might still be enough of a market in India. 2. Indias poor Muslims face a real problem in accessing organised financial services, and this is the same problem that the rest of Indias poor face. Greater financial inclusion, such as no-frills-banking accounts, and higher banking outreach will fix this. The fastest way to do this is enhancing competition. 3. Indias poor Muslims face an additional problem over other poor people in that they live in ghettos, and so have trouble accessing credit. The solution to this probably cant come from the banking system, but from NBFIs, subprime borrowers, or community finance

institutions. If these institutions could be plugged into a credit grading system, it would help. 4. Tweaking financial products to make them Shariah-compliant is not very hard. However, as the Percy Mistry report has pointed out, the way the RBI conducts regulation makes developing any new product hard. This is a separate challenge, and worth many blogposts.

Banking on faith: Islamic (shariah) banking and its prospects in India

In this era where trends flourish around increasing aspirations to identify with social conscious initiatives, it comes as no surprise that Islamic Banking is booming. The concept of interest is fundamental to the business of banking. With this background it is very interesting that sharia banking is working without profits and is still flourishing. They are not only profitable but are also growing at an astonishing rate in sense of capital, assets and consumers. From Jakarta to Jeddah to Jordan, 280 Islamic banks operate in over 50 countries, with assets estimated between $ 250 million and $ 300 billion. Management Consultants Mckinsey and Co. says in their world Islamic Competitiveness Report, 2007 that the value of assets managed by Islamic Banks will grow by 33 % by 2010. Keeping all this as background this article explores Islamic Banking in totality: origin, principles, growths and future and the possibility of the same in India.

Legislation
Existing banking laws do not permit banks to engage directly in business enterprises using depositors funds. But this is the basic asset acquiring method of Islamic banks. Therefore new legislation and/or government authorization are necessary to establish such banks. In Iran a comprehensive legislation was passed to establish Islamic banks. In Pakistan the Central Bank was authorized to take the necessary steps. In other countries either the banks found ways of using existing regulations or were given special accommodation. In spite of this, there is still need for further auxiliary legislation in order to fully realize the goals of Islamic banking.

Tax regulations
Another important consideration is the tax procedures in non-Muslim countries. While interest is a passive income, profit is an earned income which is treated differently. In addition, in trade financing there are title

transfers twice -- once from seller to bank and then from bank to buyer -and therefore twice taxed on this account decreasing the profitability of the venture.

Discussion and suggestions

People have needs like food, clothes, houses, machinery, services; the list is endless. Entrepreneurs perceive these needs and develop ways and means of catering to them. They advertise their products and services, peoples expectations are raised and people become customers of the entrepreneur. If the customers needs are fulfilled according to their expectations they continue to patronize the entrepreneur and his enterprise flourishes. Otherwise his enterprise fails and people take to other entrepreneurs.

Conclusions
Islamic banking is a very young concept. Yet it has already been implemented as the only system in two Muslim countries; there are Islamic banks in many Muslim countries and a few in non-Muslim countries as well. Despite the successful acceptance there are problems. These problems are mainly in the area of financing. With only minor changes in their practices, Islamic banks can get rid of all their cumbersome, burdensome and sometimes doubtful forms of financing and offer a clean and efficient interest-free banking. All the necessary ingredients are already there. The modified system will make use of only two forms of financing -- loans with a service charge and Mudaraba participatory financing -- both of which are fully accepted by all Muslim writers on the subject. Such a system will offer an effective banking system where Islamic banking is obligatory and a powerful alternative to conventional banking where both co-exist. Additionally, such a system will have no problem in obtaining authorization to operate in non-Muslim countries. Participatory financing is a unique feature of Islamic banking, and can offer responsible financing to socially and economically relevant development projects. This is an additional service Islamic banks offer over and above the traditional services provided by conventional commercial banks.

Reference
http://www.islamic-banking.com http://www.megaevents.net http://www.islamicbankingandfinance.com http://www.google.com http://www.yahoo.com http://www.muslim-investor.com http://www.islamonline.net
Interest free commercial banking book (Chapter 4) [Author: A.L.M. Abdul Gafoor]

ACKNOWLEDGEMENT
It gives us great pleasure to declare that our project on ISLAMIC BANKING has been prepared purely from the point of view of students requirements. This project covers all the information pertaining to ISLAMIC BANKING. We tried our best to write the project in simple and lucid manner. We tried to avoid unnecessary discussions and details. At the same time it provides all the necessary information. We feel that it would be of immense help to students as well as all others in updating their knowledge. We express my gratitude towards my project guide Prof. SHANKAR IYER who made us confident to choose this topic and helped us to get the information and also to go ahead with the preparation of the project. We would express our indebtedness to our family, friends, and those all who have helped me directly or indirectly with their constant support and for infusing us with enthusiasm to achieve the bouquet successfully.