Professional Documents
Culture Documents
about some aspects of both Islamic banking and banking for Muslims in India.
A few caveats: I have only a little more than a year’s experience in banking, and I’m no
expert, but I would hopefully have a greater degree of insight than the lay reader. Also,
this post does not have any central theme, but is more a collection of responses to the
points raised in the Mutiny.in blogpost, as well as some additional points on the subject
I thought would be worth raising.
I’ve known many Muslims who 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. I’m currently working in small business banking,
and several of my customers are Muslim-owned partnerships who are borrowing crores.
So Sandil’s point that there are Indian Muslims who have no compunctions about
dealing with debt and interest is valid. However, I was working in personal banking for a
while. Over there, me and my colleagues had to deal with a number of other Muslim
customers who had a more orthodox approach. They would deal with the prohibition on
interest and insurance in a variety of ways, including:
Obviously, I would never have come into contact with Muslims who were so orthodox
that they did not utilise banking services at all. The size of that market is anybody’s
guess.
It would be best if existing retail banks offer Islamic products within their current
schemes and carry out their ledger-separation, overlooked by a Shariah authority,
who can certify that the profit is indeed separated. Besides, it offers a more legitimate
front – the Sena would have to think twice before attacking at a larger and more
‘legitimate’ organization like ICICI, Stancy, HDFC or HSBC.
Existing retail banks, including my employer are in fact anxious to do exactly this.
Malaysia and the UAE are the laboratory where domestic and foreign banks are
concurrently running Shariah and non-Shariah compliant products. HSBC’s Islamic
mortgage in Malaysia has apparently been quite a success, and Standard Chartered has
recently launched a Shariah-compliant credit card in the UAE.
When I was working in personal banking, I had to investigate a transaction that showed
up on the money-laundering alerts. A current account which had been lying dormant for
almost three years suddenly had a huge sum credited to it. I went to meet the customer.
When I got there, it turned out that the customer was a trust representing a number of
local Muslims. They had pooled in money four years ago, used it to invest in real estate,
develop it, and had now sold the property. The sales proceeds had been deposited into
the account, and would be distributed again to the contributors. They had done this
because they felt that this was more moral then investing in debt (interest prohibited),
or in equity (too much akin to gambling).
This is quite fascinating. Long before REITs had been permitted by the Indian state, a
group of Bombay Muslims had gone ahead and created a synthetic-REIT on their own.
The diversification and risk management was much lower than a real-REIT, but there is
a lesson here: marketing to Muslims who worry about the ethics of their financial
product does not necessarily need an Islamic banking label.
No.
A much bigger problem faced by India’s Muslims is that the majority of them are too
poor to be targeted by the banking system as serious customers. Financial exclusion of
the poor is a much bigger worry for them than the absence of Islamic banking. And of
course there’s the whole issue of ‘negative areas’, which I’ll address shortly.
When my employer was conducting market research on Islamic banking in Pakistan and
the Gulf, it discovered that Shariah-compliance was ’sufficient but not necessary’.
Customers would readily use traditional banking services, but if they were offered an
alternative which was Shariah-compliant, they would feel happier with that and switch
to it. If the same insights hold good in India, it’s clear that bringing Muslims into the
financial system requires financial inclusion rather than Islamic banking.
This difficulty arises not because of actual negative scoring for Muslims, but because the
neighbourhoods which are classified as negative, no-lending areas, are usually ones
which have high Muslim or Dalit populations.
Honestly, I’m not sure why this is. My employer is committed to diversity, opposed to
discrimination, and also operates in several Muslim countries. At least at a global level,
it doesn’t have anything against Muslims. So 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. I think this is the most likely reason.
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. India’s poor Muslims face a real problem in accessing organised financial services,
and this is the same problem that the rest of India’s 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. India’s 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 can’t
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.
Sidebar from Prashant: As we’ve said earlier, IEB’s always looking for new
contributors.
Comments (49)
49 Comments »
1. [...] A great post on the Indian economy blog on the various facets of Islamic
banking, Is Islamic banking the magic bullet which will pull India’s Muslims
into the financial system and enable them to access credit and secure their
savings? [...]
2. hope you have heard of the Ahmedabad-based Parsoli finance company. they are
looking to launch a shariah-compliant mutual fund targetted at Middle Eastern
investors looking to invest in India. Obviously, there is a wall of money waiting to
enter the Indian markets under the shariah-compliant banner.
3. Some great points on here that I did not know of. Definitely worth a few
discussions on here.
Prashanth, I would think the “negative trap” need not stereotype the typical
basthi communities of lower income muslims. In any case this would be a
separate discussion altogether as I would imagine even low income Hindus,
Christians etc would have a hard time getting credit worthiness.
I would be interested to know more how wealthy muslims operate. Most prime
properties all over India are largely owned by the muslim community. Real estate
in Bandra & Khar in Mumbai or Cunningham Road and the old Cox Towns and
Fraser Towns of East Bangalore are all now largely muslim owned real estate.
Negative stereotypes aside these guys move huge amounts of money period.
5. Waw It’s great post on Indian Economy. I think Indian economy is second fatest
growing economy after China. The savings of Muslims also increase this rate it is
my hope.
6. Why are we writing about this here? I always thought the posts here are of
“secular” nature, but within no time we are talking about Sharia laws and
banking, you might as well change the name of this blog to
http://www.pakistaneconomy.org
Is India and Indians so poor that they have to attract funds from so called Sharia
banks and funds?
7. Great post! And great insight into the issue by blogger! Keep it going!
8. Bank is bank, why one has to place an “Islamic” label in front? As in the case of
India, the racial harmony is always a major issue, labeling banking activities as
“Islamic” might carry a real potential risk for misunderstanding or subtle
segregation of communities and commercial activities. You rarely hear such
terms in esat asia and north america.
9. we can have tamil, telugu, marati , gujarathi etc banks also. they will be limited to
respective people and let them create some more discrimination among people
live aound. we already have states, we can have districts and cities also language
and cast wise, that we groups can grow in groups and become like frogs in well.
Try to think everyone like human first, then write about this kind of nonsence
blogs.
10. I’m pretty surprized to see some of the comments above that are blindly
passionate and didnt respond to the artilce, per se. For good or bad, Islam has a
separate law wrt handling money, and instead of questioning on why they have
such a law, it is more prudent to utilize that from a pure economical perspective.
A lot of wealthy customers with big bucks from Middle east can be brought more
closely to the banking system and the money could be used more productively
which could otherwise end up in questionable activities like Hawala, Money
laundering or even go into indirectly funding terrorists without the participants
knowing about.
Its always dangerous to have money lurking around in non-official forms, and
Islamic banking would enable atleast a part of the money to enter official
channels. The banks could also benefit by 0 or low interest deposits from those
customers and a bigger client-base. Its a win-win for everybody, and the
concerned parties must engage the general public and convince them that this is
not surrender to minority interests.
11. I’m shocked at some of the comments and surprised that readers of the Indian
Economy blog would react such.
It takes skimming of the article to see that Islamic Banking has nothing to do
with religion or favoritism towards Muslims; all it does is have a banking system
which tweaks itself to Shariat laws … according to which interest is not paid, as
mentioned Muslims get by in regular savings account by donating the interest
accrued to them to charity. Even Shariat Funds are mostly such that do not invest
in Businesses such as Alcohol, gambling etc. Very similar to Green Funds and
Christian Funds.
The comments just expose the very deep rooted prejudices against Muslims even
in urban and well-educated India. I also sincerely believe and hope that these
people are in a minority.
12. I think this blog gave us a nice perspective on showing that ‘Islamic banking’ may
be a good tool for banks to use from a marketing perspective. In markets where
we already have Muslims using banking services, this tool can give some banks an
edge over the others since they ’seem’ to comply with the Islamic laws, and hence
will be more preferred. From a new product development and launch perspective
it may be useful in markets where there are a lot of wealthy Muslims, and key
influencer to purchase might be religious sentiments, like some middle eastern
countries, which are keeping these Muslims from buying financial products and
servicing. However, in India, I agree that what is most important, and more
profitable for banks in the long run, is to understand that this is a financial
inclusion issue.
13. Dear friends, I see some of you shocked at just reading the comments written by
others, but that may be reality. Shariat laws may be applicable somewhere where
lot of rich people are their where they may not need interest on savings account.
But do you think same thing can be done in india too?. ok even if it is done what
about the poor hard working Muslims are they not deserved to get interest earned
from savings when they bank with such bank?. how ideal is this to assume that
rich people will put their money in banks than putting somewhere else?
without even existence of a bank like this, if some rich person really want to
donate to charity he will do that anyway. i don’t understand in what way will it
benefit by opening labeled banks like this.
15. Dissenter
If you have issues with the ideas presented in the post, let\’s hear them. No need
to get into gaali-shaali… [grin]
Prashant
Comment by Prashant — September 21, 2007 @ 3:10 am
you are correct. I now realise my mistake. Setting up enterprises which follow the
dictates of one particular religion or other is sure to cause divisiveness and
unrest. Yes, we cannot allow Islamic Banking.
We must also shut down halal slaughterhouses. Either you have halal slaughter or
secular slaughter. You cannot have both.
17. personally i think islamic banking, i.e. a banking system sans ‘interest’, is merely
a concept used to satisfy ones morals. wats the point when the bank ends up
making money from you and does call it interest but through concepts like
‘murbaha’.
i think its unwise and a bit silly to mix religion with economics.
19. Well, if the problem some people feel is with the term “Islamic Banking”, I’m sure
it can be tweaked to give it a more “secular” feel. Nevertheless, more than the
actual terminology, what is important is the strategy and the concept of Islamic
banking. Banks can use it to attract greater investment, nothing to do with
religion. As Indian banks start operating outside, they realise that if they have to
cater to the Islamic markets, they would have to introduce such products.
Working in the core banking implementation field, I have come across so many
banks who want Islamic banking in our product. Since the clients require it, we
try to deliver this, without too much fuss. Of course, I’m not too sure whether the
concept will work in India.
It’s also unfortuante that readers like Dissenter should start getting abusive in
what is only a discussion. C’mon folks, can’t we just be a bit more tolearnt of each
other’s views??? Grow up…
20.Graduate,
Sorry if you have got offended.
A “bramhin darshini” is a very very small business, opening a new one or closing
an existing one will not have any consequences. On the other hand we are talking
about billions of dollars here, which may be floating around in the Sharia funds.
As it is, there is a growing unease among many sections (and rightly so) about the
sources and uses of these funds that come, mainly from the middle east, who may
be inmical to Indian interests. After the US and western countries tightened their
banking laws, a lot of unsavoury funds have started making their appearances in
these forms in the Asian markets.
Secondly, money is a commodity which has a rent, which we call “interest”. If
interest is “bad” due to religious diktats, then some religious banks will simply
levy it but will not call it by that name.
If not, then the lending by the bank, is similar to a venture capital fund financing
a client, or buying shares in the clients company. There is nothing called Sharia in
this whole exercise. Thirdly interest paid on loans is tax deductible in most
countries, for businesses and on certain loans like housing loans for individuals.
How do you propose that the banks that offer Sharia funds to borrowers will deal
with this? Pay more tax? Pay dividend tax?
Or let the client pay more as “service charges”?
21. Dissenter,
I think you were much more offended than I was. :)
I think I missed out two things in the post. First, that I’m not suggesting that
Islamic banking substitute regular banking, but just that it be added to the
product portfolio of existing banks. Second, I am in no way suggesting that
Muslims be compelled to use only Islamic banks.
As to your points,
1. If Islamic banking is offered as such, by existing banks, then they will have to
apply existing standards of customer due diligence, anti-money laundering, and
know-your-customer norms. While the effectiveness of these standards and the
compliance to them can be argued over, it is surely preferable to have money
flowing through the banking system than through shadier avenues like hawala or
film financing/ property dealing.
2. Levying interest and calling it by another name – true, the net cashflows are
indistinguishable from normal interest payments, and it is largely jugglery in the
structuring of the legal contract. But if it makes customers happy, why not offer
it?
3. The interest is deductible on the borrower’s income, not the bank’s income. I’m
not proposing anything, but allowing deductions on equivalent interest/ service
charges is not impossible. Or, if Sharia-compliance is that important to Muslim
borrowers, perhaps they would be willing to forgo the tax deduction.
22. Unfortunately, although “Islamic” banks may make Muslims feel good, they only
perpetuate a fixation with religion governing all aspects of life.
We all know it can not work that way if we want to have long term gains, financial
and societal.
Think of the losses. How many westerners would utilize a bank called by that
name?
24. As we all know, in the developing world there is increasing realization that the
interest-based system of the capitalist West has failed to solve the problem
of poverty and economic disparity.
The feeling is that the minds are overwhelmed with the Western thoughts and
the vested interests siege the World Banking system, which are
engaged in poisoning minds and shaking the feet of the weak minded people.
The need is to break the idols inhabiting the minds and the way of the
submission of the mind and vision to God’s commandments should be adopted.
Many feel quite strongly about the idea of interest-free banking and this
common bond goes a long way towards encouraging good behaviour.
The Shariah, requires that reward comes from risk sharing. Profit must be
justified through the creation of value that the banker brings to complement the
value of the borrower’s efforts and skills.
Against a background of rapid growth in Middle Eastern economies over the last
20 years and a desire to increasingly compete internationally, Islamic banks have
begun to change and develop to provide a range of alternative financial products
Regulatory issues need to be sorted out before Islamic banking can be introduced
and its benefits can be enjoyed to the fullest and its fruits felt and shared in other
parts of South Asia to begin with.
Islamic banks can provide housing loan, on the basis of co-ownership, venture
finance on Mudarabah basis as well as on Musharaka basis and consumer loans,
finance purchase of automobiles on a hire-purchase basis. Education and skill
development finance. Investments can be made in government securities, small
savings schemes or units of mutual funds. These banks can also invest in shares
of companies. Hire-purchase and lease finance are other source of investments.
To have a smooth functioning of these financial institutions law of the land will
be always paramount and there are no two opinions about this, legalities,
transparency and respect for the local law are the basics of Islamic Shariah in the
mean time the government should devise an efficient legal system to safeguard
the interest-free banking practice against any misuse.
25. Manzoor, I like what you have written but it wasn’t necessary to dig at the
“interest system of the capitalist west”. You have some good points to say but you
have to be more neutral on here in your opinions no matter how strongly you
believe in them.
Mind you following the recent US sub-prime crisis there may be quite a few who
would appreciate Islamic banking. And only a command from the heavens would
get me to completely trash the concept of interest or the price of credit. But it is a
concept worth spending time on … and I did.
It is not only Islam that abhors credit. Medieval Christian thinking treated time
as the property of God. Therefore charging interest was to do commerce with
God’s property. Things have changed since in the Christian world of course but
notable proponents were people like Thomas Aquinas a leading Catholic thinker.
26. As a practitioner and deep believer in Islamic Finance who hails from a Hindu
Brahmin Family I do think the trail of comments in this post has revealed a deep
seated ignorance and prejudice that we have towards Muslims in India.
I would refer all readers to the following book, the ‘future of money’, by Bernard
Lietar – where he expertly highlights the intrinsic dangers of interest and then
mentions how Islam (whether) you agree with it or not – has admirably
represented the last bastion of resistance. He illsutrates how interest is a direct
cause of inflation, wealth imbalance contributing to the rich getting richer and
the poor getting poorer.
27. Sumit,
Can you try to be not so condescending to Indians and their “deep seated”
prejudices for muslims or any one else ? The points raised by Dissenter about
large amouunt of money flowing in from the Middle East under the guise of
Islamic banking is a very valid one – it could very easily be used as a conduit for
terrorists.
The very concept of a bank exists because of interest rates. The civilized world
would not be able to operate if there is no reliable cash supply/flow and interest
rates have a huge bearing on this area.
You seem to have an anti capitalist/communist mindset when you throw around
words like wealth imbalance. It may come as a big surprise for you but there is no
requirement in this country or any other democratic state that every one should
be equally wealthy. Wealth is what you create based on your talents, smarts and
your hard work. As long as people have equal opportunities to come up in life and
create wealth for themsleves, we should all be happy.
Communism and Socialism made terrible efforts to “correct” this imbalance and
did so at the enormous expense of personal liberty and freedom. Poor becoming
poorer was a phenomenon in communist countries that was even worse than in
any other capitalist economy.
May be you should see if the oil rich Arab countries take the profits that they earn
from the West through energy supply and put it entirely into an Islamic banking
account backed by Sharia laws before trying to enlighten the rest of us.
28.Manzoor,
You have written that Shariah funds also invest in Government securities. How
do they earn a return on them, if interest is not paid? Since most governments
have large deficits, there is no possibility of them ever making a profit on any
public venture nowadays. Secondly, you say that the Islamic Banker loses his
investment, if the venture into which the money has invested, fails. This means it
is possible in an Islamic Banking system that all assets can be wiped off because
the banker made a poor decision. Also since the borrower is under no obligation
to pay interest, he may not be really keen, to even return the principal amount. If
this happens, what happens then? Or do they get punished under other Shariah
laws? Imagine pension funds being invested in this way.
You say that the subprime crisis would not have happened under an Interest free
regime. I beg to disagree.In fact if there was no obligation for borrowers to pay
any interest, the subprime crisis would have been not just worse, much more
worse. People would have bought 10 houses instead of just 1-2 with cheap
(interest free funds) and kept on speculating under the whole economy collapsed.
Interest on money is not just a rent on money, it also encourages borrowers to
borrow only when they are confident of getting a superior return on the money
which covers the interest. Just as vey high interest rates are bad for the economy,
very low (such as zero) are worse, because you are essentially giving away free
money.
And yes, various religions have wailed against interest, but that doesn’t make it
right. Spirituality comes from God; religions come from man; and man is biased
against profit. See _The Myth of the Rational Voter_, by Bryan Caplan.
31. NS,
You mentioned:
“The points raised by Dissenter about large amouunt of money flowing in from
the Middle East under the guise of Islamic banking is a very valid one – it could
very easily be used as a conduit for terrorists.”
I say:
Islamic Finance is purely a mode of financing, it is the mode that is of concern to
Islamically inclined investors – the underlying investments would be those funds,
businesses who would just need to streamline their activities and operations in
accordance with the financial requirements – as is similar to ethical investing.
How does this equate to financing terrorits – except perhaps for someone whose
mind is already accustomed to equate the word Islam with terrorism. I simply
dont understand how Islamic banking is linked as a conduit for terrorists, do you
think if someone wants to destroy the infrastructure of a country they are going
to be obsessed with how they finance it ?! Due to the added strings of Islamic
Finance and diligence/compliance/attention required it would be more difficult
for any terrorist financing where anonymity is the order of the day…so forgive me
for assuming some prejudices here.
Not all Banks operate on Interest rates – venture capitalist and equity financing
dont..and reliable cash flows do not simply come through charging ‘rent’ on
money as advocated by another commenter – all that does is make the rich,
richer and the poor, poorer. Just to clear the air..I am not a socialist, I think the
idea of everyone earning the same irrelevant of effort and action is flawed and
history proved so, but I not an unbridled capitalist either. The current banking
system and interest being the main culprit has grossly imbalanced wealth in the
world – which is why 250 people of the richest people in the world have more
than 2.5 billion of the rest of the world. This is what Bernard Lietar points out in
his book, that Interest amplifies wealth distortion – a recent report
commissioned by the World Bank itself concluded that not one of the nominal
interest loans proved beneficial in the ultimate sense for the economies they were
forwarded to.
The only argument for interest exists on the micro level as far as Im concerned
(*micro finance) and that is because there is the problem of not being able to
adequately book keep as to allow for profit distribution.
Finally, the word ‘bank’ in the parlance you ascribe is a financial intermidiary –
‘Islamic Banks’ are more Investment Banks akin to Venture Capitalist Financing.
32. The following story illustrates one of the deeper causes of the endless quest for
growth that underpins our modern consumer society – INTEREST. The story and
adapted comments are from the book The Future of Money (pp. 50 – 53) by
Bernard Lietar. Your thoughts, comments and discussion are welcomed and
appreciated.
***
Once upon a time, in a small village in the Outback, people used to barter for all
their transactions. On every market day, people walked around with chickens,
eggs, hams and breads, and engaged in prolonged negotiations among
themselves to exchange what they needed. At key periods of the year, like
harvests or whenever someone’s barn needed repairs after a big storm, people
recalled the tradition of helping each other out that they had brought from the
old country. They knew that if they had a problem some day, others would aid
them in return.
One market day, a stranger with shiny black shoes and an elegant white hat came
by and observed the whole process with a sardonic smile. When he saw one
farmer running around to corral the six chickens he wanted to exchange for a big
ham, he could not refrain from laughing. “Poor people” he said. “So primitive.”
The farmer’s wife overhead him and challenged the stranger, “Do you think you
can do a better job handling chickens?” “Chickens, no,” responded the stranger.
“But there is a much better way to eliminate all that hassle.” “Oh yes, how so?”
asked the woman. “See that tree there?” the stranger replied. “Well, I will go wait
there for one of you to bring me one large cowhide. Then have every family come
visit me. I’ll explain the better way.”
And so it happened. He took the cowhide, and cut perfect leather rounds in it,
and put an elaborate and graceful little stamp on each round. Then he gave to
each family ten rounds, and explained that each represented the value of one
chicken. “Now you can trade and bargain with the rounds instead of the unwieldy
chickens,” he explained.
It made sense. Everyone was impressed with the man with the shiny shoes and
inspiring hat.
“Oh, by the way,” he added after every family had received their ten rounds, “in a
year’s time, I will come back and sit under the same tree. I want you each to bring
me back 11 rounds. That 11th round is a token of appreciation for the
technological improvement I just made possible in your lives.” “But where will
the 11th round come from?” asked the farmer with the six chickens. “You’ll see,”
said the man with a reassuring smile.
Analysis
Assuming that the population and its annual production remain exactly the same
during the next year, what do you think had to happen? Remember that the 11th
round was never created. Therefore, bottom line, one of each 11 families will have
to lose all its rounds, even if everyone managed his affairs well, in order to
provide the 11th round to ten others.
So when a storm threatened the crop of one of the families, people became less
generous with their time to help bring it in before disaster struck. While it was
much more convenient to exchange the rounds instead of the chickens on market
days, the new game also had the unintended side effect of actively discouraging
the spontaneous cooperation that was traditional in the village. Instead, the new
money game was generating a systemic undertow of competition among all the
participants.
Commentary
This is how today’s money system pits participants in the economy against each
other. The story isolates the role of interest – the eleventh round – as part of the
money creation process, and its impact on the participants. When the bank
creates money by providing you with your $100,000 mortgage, it creates only the
principal. However, it expects you to bring back $200,000 over the next twenty
years or so. If you don’t, you’ll lose your house. Your bank does not create the
interest; it sends you out into the world to battle against everyone else to bring
back the second $100,000. Since all the other banks do exactly the same thing,
the system requires that some participants go bankrupt in order to provide you
with this additional $100,000. To put it simply, when you pay back interest on
your loan, you are using someone else’s principal.
In other words, the device used to create the scarcity indispensable for a bank-
debt system to function involves having people compete for money that has not
been created, and penalizes them with bankruptcy whenever they do not succeed.
. . No wonder ‘it is a tough world out there.’
33. Sumit, nice story but I lost the plot a little – are you saying constant economic
growth is the other side of the same coin namely interest?
Russ Nelson & others, have you heard of “paradigm shifts”? Its the stuff that
causes revolutions or massive change. When the world was flat, Kepler caused a
paradigm shift with the planetary model. We all understand the concept of
interest but what if we challenge the premise when problems occur as they
certainly have very recently.
Just ask Merrill Lynch of their $8 billion problem. Soon others are going to
follow suit. Merrill Lynch is just the first to bite the bullet. Citigroup who
invented the whole thing with Structured Investment Vehicles (SIVs) may be
next. There is about $400 billion worth of “investments” out there for which
demand has mostly dried up.
Folks like Merrill’s recently fired CMD, Stan O’Neal and others are likely to be
begging for consideration of “non-economic concepts” like mercy, forgiveness,
compassion etc. And why not. After all they are as real as anything else in
economics. It’s just that they haven’t been tied to economics or attached with any
amount of significance.
This is where Islamic banking or any other name for a similar system holds
interest for me. Can we consider alternate ways to address the concept of the cost
of money?
34. Hi,
Islamic Banking is not required until the banking sector assures us that they are
not involving our funds and giving us the profit from Haram elements like
Alcohol, Pubs, lending money on intrest etc… Rather we are ready to put our hard
earned money if they are investing on infratructure, pharma, education,
realestate etc…
I being a salaried person earning 45k permonth have a large problem to save my
money without intrest think about other who earn more and more.. i could just
count some 1500 person in my 2 KM area who will be open to invest the next day
it start. can u have a count in india.
what bank offers in saving account is nominal interest rate. so real interest rate
may be zero depending on the inflation. Which part is prohibated as per Islamic
laws?
since such account wont be paying interest to the depositor, so will banks charge
less money when lending them out? There is a possibility that banks site higher
transaction costs for these accounts (seperate ledger, monitoring of investment,
etc) and charge same LR on them.
36. What are the chances that “islamic banking” would have gained greater
acceptance without the I word ? If people can invest in “green funds” and other
such dedicated avenues, why not “interest-free banking” ?
@Siddiqui – theres a snowballs chance in hell anyone is going to give you the
assurances you want. Remember, its the taxes of alcohol and ciggies that keeps
our creaking infrastructure going. And if you really want to be sharia compliant
look at one of the Tata Equity Funds- i’m told one of them is S-C.
Besides, smoking and any other such “vices” doesnt make SRK a bad muslim only
a potential cancer patient so i dont think muslims as a whole are perturbed by
alcohol or ciggie companies !
37. Hi All,
Nikhil said:
*Sumit, nice story but I lost the plot a little – are you saying constant economic
growth is the other side of the same coin namely interest?*
The story was used by Bernard Lietar to illustrate how interest as a mechanism,
creates a debt that doesnt exist – with the effect that somebody has to suffer (i.e.
lose their money or go bankrupt) to pay off the interest. You illustrate some
interesting points about ‘interest’ (sorry about the pun, somebody had to do it)
and the concept of money. It is precisely about the concept of money, which is
why Interest(called usury) has been forbidden in almost all traditional cultures
-money was never viewed as an asset itself but rather a conduit, a means of
exchange (as most traditional ecoonmies were Barter economoies). Amongst
prominent names Aristotle, Thomas Aquinas and Imam Ghazali wrote
extensively about the dangers of viewing money as an asset itself (thereby
justifying the chargaing of rent – which is amongst the dominant justifications of
interest).
Of course this is where we stop, because we know that conventional finance views
money as an asset. It is proven through numerous studies that asset and equity
financing is a better performer than debt financaing, this is in essence what
Islamic finance is.
There are alternative systems of economics being expoused based on the Islamic
paradigm by people who arent Muslims – please do a wikipedia search on Binary
Economics and Rodney Shakespeare.
Dear Siddiqui – I think the Tata Equity Fund sounds good(though I havent seen
the Fund), there is the Mahendra Fund, Parsoli Equity Fund, the State Bank has
an Islamic Fund coming soon…Im sure if you look around you will find lots of
stuff.
Raj said:*what bank offers in saving account is nominal interest rate. so real
interest rate may be zero depending on the inflation. Which part is prohibated as
per Islamic laws?*
Well thats a valid point, the econmic effect of interest in terms of being at par
with inflation would mean the money is not growing – but the reason why
interest is prohibited in Islam is because it is an abuse of the function of money
itself – so compound, nominal, fixed, floating and all other types of interest are
forbidden. Infact interest as illustrated by many economists is the primary cause
of our inflation driven environment itself..so to justyfiy intrest because of
inflation is a circular argument. In an asset back currency such as Gold, the
buying power should stay the same – although one would note that the price of
Gold has changed over time, it is not because of Gold’s intrinsic value changing
but because of the fact that currency is no longer of any value except in
percpetion and the so the amount of gold bought by our paper changes . Post
Bretton Woods, even the dollar is not pegged to Gold…so your money actually is
simply a promise to pay what doesnt exist and only represents value as long as
people accept it..if we all rushed a bank at the same time..that would crash the
economy. Islamic Finance in its ideal is about real money (preferably Gold and
Silver), real investments and asset backed finance.
*What are the chances that “islamic banking” would have gained greater
acceptance without the I word ? If people can invest in “green funds” and other
such dedicated avenues, why not “interest-free banking” ?*
Yes, the ‘I’ word lends terrible connoations in the non ‘I’ word, especially post
11th. The issue is that the Finance world has to demaracte it – it doesnt fit in with
interest free banking (because there are many ethical injuctions) and it doesnt fit
in with contemporary ethical banking (because most eithical funds do not regard
investing in pork and interest as wrong or unethical). Efforts are underway to
create some sort of paradigm between ethical and Islamic Banking as there is
huge overlap barring some areas. Of course, some people take exception to
ernaming Islamic Banking as ethical banking as they feel that may lend a holier
than thou attitide, implying that others arent. It was felt that the name best fitted
as its primary market would always be people concerned about Islamic injuctions
towards finance and econopmics. Of course, you can agree with the philiosophy
and passionately believe it proposes an alternative to the current system without
being a Muslim – but often that requires a need to think beyond a tribalist
mindset and looking beyond the ‘I’ word.
38.A Few words from a very close friend adressing the role of money as a commodity
and inflation:
* Why does Islam forbid interest when money is just another commodity that
comes at a price? *
Unlike an actual commodity (like gold, which has traditionally been the standard
of measure for currencies), money has no intrinsic value. It
derives its value from something other than itself, namely, market demand.
*If Islam forbids fixed-income interest, what’s wrong with floating-rate interest?
Doesn’t it allow raise and fall like profit? *
Islam does not forbid fixation. It is permissible to fix profits (in percentage, not
absolute, terms), prices, rents and instalment plans,to name a few measure. But it
is forbidden to exchange money for a
larger amount of money (unless the currency is different, in which case it is
permissible at spot). The unlike exchange of like moneys creates
riba. But exchanging assets or services for money and money for assets and
services is entirely permissible. So the problem does not relate to whether an
interest rate is fixed or floating, but to the interest itself.
The short answer: because interest from an Islamic perspective is still wrong.
Charging interest to compensate for interest is analogous to terrorising civilians
to compensate for global injustice: two wrongs do not make a right.
*Stocks are like gambling, but Islam permits stocks and forbids gambling. Why? *
This returns to the basic principle of asset and service backing. Stocks invest in
real assets (a company’s property, plant and equipment) and
actual services (a company’s management expertise). Gambling invests in
nothing.
Even if a lottery funds charities or finances public works, the money with which it
does so is still invested underlyingly in nothing – a number,a ticket, etc.
Also if someone is truly seeking to get funding there are many options available.
Venture capitalists, Angel investors just to name a few.
41. Sumit,
I think you are way to impressed by that book of yours. It has some decent points
to make, but it fails to acknowledge that money supplies liquidity. It is not just
junk paper. Some sovereign govt. backs this paper saying that it should buy some
real commodity (rice, grains, clothes, etc.). The barter system had the most direct
value (chicken for pork, etc.), but it was still unwieldy. Example – if I wanted to
buy a home, how many chickens would I have to grow and barter? Economics has
evolved, just like many things.
You seem very impressed with Islamic finance, and it is okay for you to be
impressed. But my understanding of Vedic texts tells me that nothing has the
potential to be more sacred than the human mind. If the mind is sacred,
everything else is. It doesn’t matter if I am taking interest or giving interest or
whatever. Since money or asset or whatever you are to call it is only to sustain my
physical existence anyway. Not my soul. If a human being knows how to control
his/her mind, then the battle of existence on this planet is won anyway. I don’t
need some sharia law written millenias back to tell me how to treat my mode of
sustenance aka money/asset/et al.
My problem with Islamic banking, and with entire Islam (and evangelical
Christianity) is that they govern people’s lives way too much! Eat this way, dress
this way, treat your women this way, treat your money this way, think of God this
way, think of evolution this way, et cetera, et cetera. It never ends. I believe in
total freedom of my physical self and of my mental and spiritual self. You can see
how someone like me would have a problem with the I-banking.
It is time that someone tells these Islamic proponents that a religion’s job is to
lead people towards true spirituality and not to govern their lives.
No dis respect meant to Muslims. I am just giving a valid criticism of how I think
of their culture and religion as an outsider.
First, there are three components of “interest”: rent, risk, and inflation. When
somebody gives up use of their money, it is just like giving up use of their house,
so they expect to be paid a rent for the use of their money. Same thing for the risk
of harm: that’s why loans usually have collateral and flat rents usually require
first and last month’s rent. But a component of the interest will cover the risk that
the collateral doesn’t cover. And when the central bank inflates the currency,
money later is worth less than money now, so a loan may require higher
repayments with neither rent nor risk, but only to cover inflation.
And yes, various religions have wailed against interest, but that doesn’t make it
right. Spirituality comes from God; religions come from man; and man is biased
against profit. See _The Myth of the Rational Voter_, by Bryan Caplan.
Islamic Banking, Finance and all ‘rules’ that Islam has, are a subset of this
philosophy. Ask the many businessmen who would fly in the air if there were no
interest charged on their loans, in exchange for a share in the business by the
bank.
I would earnestly request you’ll to avoid senseless critcism and do good research
before commenting on a topic. Also avoid abuses. This is a thread not a wrestling
ring.
Regards,
Ezaz, India
Comment by Ezaz — March 22, 2008 @ 9:10 pm
The CFSR (the High Level Committee on Financial Sector Reforms) has almost
received all public comments over their draft report and may be busy in
preparation of the final report, which may be submitted to the planning
commission of India somewhere in the month of September 2008. It is possible
that CFSR may miss some issues related to economic justice and financial
stability of the nation. The approach of CFSR was not to arch the financial
structure for inclusive growth; rather it was to promote the businesses of existing
financial enterprises. Majority of the commentators over CFSR draft report were
intended to snatch economic advantage from possible reforms and majority were
basically guided by corporate forces. They are interesting to resolve their
constraints compared to resolve the financial constraints restricting inclusive
growth of India.
If CFSR is sincerely making the reform proposals, I would just like to know some
facts related to following issues.
The database and information sources are not available to general people;
otherwise we would have drawn up the sketch of our financial sector reforms.
Nevertheless, it is expected that still 60% Indians are deprived of formal sector
banking and financial services, and just not more than 10% of national savings
are transformed into capital by stock markets. The financial and economic plight
of unorganized sector workers need serious and sincere efforts by our planners
and policy makers because despite 60 years of independence, our financial sector
and ministries are governed by few capitalists from corporate sector. Hardly have
we seen any representation of the unorganized sector in making reforms
processes.
Now if we really desire inclusive growth of India, we have to focus our efforts to
resolve the problems associated with the unorganized sector where around 94%
Indian workers are making their livelihood. Moreover, we have to ensure that our
maximum savings should be converted into capital through investments in
equities. Moreover we have to adopt some practices to ensure fair trade in stock
market and prevent ditching game by speculators.
Without financial sector reforms in the unorganized sector we may not be able to
help majority of Indians. If we have to see India grow in inclusive manner, we
need to help the unorganized sector worker which is just possible through
reforms for the unorganized sector. The reforms in formal sector will not help
reduce poverty and income disparity.
With recent trend of increased capital inflow into India the aggregate deposits by
Scheduled Commercial Banks (SCBs) has increased from 80.7% in 2005-06 (Rs.
21,09,049 crores) to 102% (Rs. 31,96,939 crores) of GDP at factor cost by 2007-
08. With increased deposits, the bank credits has also increased from Rs.
15,07,077 crores in 2005-06 to Rs. 23,61,914 crores by 2007-08 reflecting 75.6%
of GDP at factor cost in 2007-08 as credit against 57.7% in 2005-06. This indeed
is a situation, where our economists, financial sector regulators and bankers need
to review the policy and practices adopted by RBI as we take interest as a major
tool to control liquidity but we hardly evaluate the far reaching consequences of
interest in our economic process.
Our real term GDP growth rate (= GDP growth rate at factor cost – rate of
inflation) has considerably declined from 5.2% in 2005-06 to 2.9% by 2006-07
and fell down to1.6% by 2007-08. As the interest increases the cost of credit and
output, even the GDP value is inflated through interest. Thus the higher GDP
growth rate like 9% just reflects 1.6% real term GDP growth rate if inflation rate
is 7.4%. The liquidity theory of J. M. Keynes is failed here to guide RBI optimize
these opportunities. The practical approach of RBI to curb the rate of inflation by
increasing the rate of interest may not control inflation and might lead towards
stagflation as the prices are continue to increase along with purchasing power of
the depositors, but the expenditure, investment and net GDP growth rate is
falling due to costlier credit and interest based deposit schemes.
By increasing the rate of interest, liquidity might be controlled for shorter period,
but with increased cost of credit, the GDP value will increase that leads to
inflation. Interestingly the interest income to SCBs was Rs. 1,85,384.9 crores in
2005-06 which increased to Rs. 2,37,271.14 crores by 2006-07. It means by
2006-07 total interest income to SCBs was 7.1% of GDP at factor cost. It simply
means that the interest income to SCBs has inflated the value of GDP at factor
cost by 7.1%.
With increase in rate of interest, the aggregate deposits might increase and SCBs
may need to pays more interest over increased deposits. Total Interest expended
by SCBs over deposits was Rs. 89,742 crores in 2005-06 which increased to Rs.
1,20,261.08 crores by 2006-07 showing a net annual increase of 34%. This
growth is inflationary as it increases the buying capacity of the depositors. By
2006-07, the interest expended over deposits was around 4.20% of GDP at factor
cost.
Further to note that RBI is increasing the rate of interest for over one year to
control the inflation which ultimately increasing the cost of GDP showing higher
GDP value and increasing inflation instead of controlling it. Our total final
consumption expenditure as % of GDP at market prices is already declining from
67.8% in 2005-06 to 65.5% by 2007-08. This decline along with inflation cannot
be controlled by increase in interest rate. This economic tendency may leads to
stagflation which is more dangerous for economic stability and growth. The
unemployment rates in increasing, the investment rate is also declining; so RBI
should review its policies and practices to monitor liquidity, credit and inflation,
if we have to combat inflation and attain desirable growth rate.
Islamic economic ethics suggests mechanisms for stable and anti inflationary
monetary system which should be adopted by RBI to make our monetary system
more stable and anti inflationary. Hope the RBI will consider these ethics as
measure to combat inflation and stagflation. Islamic Banking principles and
practices will not only increase the equity deposits and finances but also promote
capitalization and investments. It will help increase employment and business
opportunities which are must for inclusive and foster growth of India at a time
where world is eying upon Indian economy for making more investments.
Otherwise consistent approach of RBI to control inflation through interest rate
may let the UPA government face cruel failures in capitalizing the investment and
growth opportunities with worst off inflation and stagflation.
Wish all the best for Indian economy, the general Indians, RBI and the UPA
government.
46.I fully support an agree with the analysis given by Mr. Syed Zahid Ahmad.
Ali Hashmi
47. Readers may kindly note that the following section has been deleted from the
actual article, so kindly do not consider those portion as part of the original
article.
“Our real term GDP growth rate (= GDP growth rate at factor cost – rate of
inflation) has considerably declined from 5.2% in 2005-06 to 2.9% by 2006-07
and fell down to1.6% by 2007-08. As the interest increases the cost of credit and
output, even the GDP value is inflated through interest. Thus the higher GDP
growth rate like 9% just reflects 1.6% real term GDP growth rate if inflation rate
is 7.4%. “
With silent debates on Islamic Banking in India among Indian Muslims, some of
our financial sector players and political leaders, time has come that besides
considering the religious, social, political and diplomatic dimensions, we should
understand the economics of Islamic banking for Indian economy.
It is expected that with introduction of Islamic banking in India, the first choice
of depositors and investors would be nationalized banks as despite contradiction
of interest, Indian Muslims have a confidence in nationalized banks. To ensure
security of deposits majority of Muslims depositors would prefer to join Islamic
banking managed by nationalized banks. However it is expected that Foreign
Investors looking to invest in India through Islamic banking, would prefer to
have services of foreign banks. As far Indian Muslims are concerned, they have to
make hard efforts to find their place in managing Islamic banking in India
because they lack required financial depth; infrastructure and more importantly
they have poor credibility among the depositors and investors due to some past
failures of financial institutions.
• The 150 millions Indian Muslims would enjoy their religious rights in banking
sector with provision to get rid of interest which is strictly prohibited in Islam.
• With introduction of Islamic banking, the UPA government may get advantage
to please the second largest community of India who are somehow uncomfortable
with linking of recent terrorist attacks with only Muslim community or in other
words by hearing the terminology of Islamic terrorism.
• With introduction of Islamic banking, Indian government will gain diplomatic
advantages to make financial dealings with Muslim dominated nations especially
to attract trillion dollars of equity finance from gulf countries.
• The operation of Islamic banking will allow the Muslims to work with majority
community in banking sector which is not found in proportion to their
population share so far, because RBI has just 0.78% Muslims and SCBs have just
2.2% Muslim employees. Similarly Muslims have a poor employment rate in
NABARD and SIDBI because every where financial institutions are dealing with
interest and Muslims do not like to work with interest based banking and
financial institutions. It is a major factor causing financial exclusion of Indian
Muslims. With Islamic banking this exclusion may be removed and it would
definitely help us build civil society economy.
Islamic Banking is rated as one of the urgent needs of Indian economy as it is the
only banking mechanism which seems to arrest the liquidity and inflation
problem along with allowing GDP growth with adequate share in all segments.
The increased percentage share in GDP by agriculture or manufacturing industry,
or per capita income growth is just not indicative of true inclusive growth. For
real inclusive growth, we have to ensure increase in income and employment
status of workers at all segments. Empirical evidences reflects that though India
has registered better growth rate in recent years, the number of poor living below
poverty line has increased in our country. It may be noted that the household
consumption is directly related to household income which has declined in recent
years; while corporate savings are directly related to income of corporate sector
which has increased. Thus we may conclude that with better GDP growth rate in
recent years, our corporate sector has snatched the fruits of growth, while
majority of work force have failed to enjoy the fruits of development.
Similarly if we analyze the share of financial sector in GDP growth, we may find
that in recent years the growth rate of financial sector has been better which
indicate that share of deposits and credits to GDP has increased. Since our SCBs
extend debt finance, these credits put interest cost as part of GDP cost which
causes inflation. While under equity finance since the credit cost is zero, the
growth of credit share to GDP cannot add cost of GDP thus cannot create
inflation. On the contrary the dividend shared by depositors on equity finance
help equitable distribution of income generated through financial sector, thus
instead of concentration of credit to corporate sector, the generated income will
be shared by household sector which would increase level of consumption,
pushing the economy on faster growth track. This is the basic difference of debt
and equity credit which needs our financial sector regulators attention. The prime
economic advantages of Islamic banking could be as following –
The Indian Muslims have a share of 7.4% in saving deposits while just get 4.7% of
credit in terms of PSAs. If we consider this as a standard proportion in national
aggregate deposits with and credits maintained by SCBs, Indian Muslims
annually loose around Rs. 66,700 crores because Muslims have a credit deposit
ratio of 47% against national average of 74%. It shows that Muslims of India
loose around 27% of their deposits by not availing as credits. After Islamic
banking this deficit may be removed to curb financial loss to Indian Muslims
because with 31% Muslims living below poverty line and 40% Muslim workers as
own account workers, the deficit of credit is like economic assassination of the
community. Muslims avail just 4% and mere 0.48% credits from special financial
institutions like NABARD and SIDBI respectively because there also the
community has to indulge in interest which is strictly prohibited in Islam.
Since Islamic banks may also have managerial control over commercial
financing, government might use banking units as source to mobilize taxes as
well which might reduce mobilization costs for public revenue and increase
margins for governments.