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Monday, 15 April 2013

The prospect for Islamic banking in India

The era of Islamic banking has finally arrived. India’s Minister for Minority Affairs K Rahman Khan recently said India could soon be implementing an Islamic banking system.

This is a welcome move for all Indians in general and 250 million Indian Muslims in particular, who do not fully participate in the interest-based financial institutions because under the Sharia (Islamic law) any return on money employed should be linked with the profit of an enterprise.

Citing the example of 75 countries which have already adopted Islamic banking, the minister very cogently argued that India could no longer afford to stay away from the $1.5-trillion Islamic financial market, which could even help address the country’s huge fiscal deficit.

Minister of State for Finance Namo Narain Meena said Rs 1.6 trillion ($27.8 billion) is lost annually due to lack of Shariah-compliant banking.

The Islamic banking industry has picked up steam across the world. This system stamped its mark in Europe when the Islamic Bank of Britain opened in London in 2003. The European Union is emerging as a major centre of Islamic finance. To cite just one example, more than 80 out of 2,000 German financial institutions provide Sharia-complaint services.

The Credit Rating & Information Services India Limited (CRISIL) says the equity-based Islamic banking system, as opposed to the system based on interest-bearing debt, would be appealing to all Indians and not just the Muslims. The reason is that debt finance leads to greater instability than equity finance. Risk-sharing in Islamic finance makes transactions more equitable.

Broadly speaking, Islamic banking products and services are based on owning and handling of assets, risk sharing transactions, leasing and commodity trading. As a mature country, India realises that Islamic banking, which deals with customers on investment grounds, will be a boon for the nation. Moreover, these banks also apply Islamic moral and ethical criteria in their financing and therefore do not invest in unhealthy industries.

The Sharia-based financial system has grown across the world particularly after the 2008 global financial crisis. During the global financial crisis, a number of big banks in the West collapsed and had to be bailed out by taxpayers' money, while Sharia–compliant banks continued outstanding growth. The key reason is that Islamic banking deals with real economy with no possibilities for speculation.

Islamic finance includes a requirement for transactions to be backed by tangible assets, profit sharing, and prohibits speculation, Riba (interest) and Gharar (excessive risk or uncertainty), the latter two (Riba and Gharar) are the reasons why Islamic banking weathered the continued global financial crisis better than its conventional counterpart.

Interest and derivative transactions, such as forwards, futures and options, as well as short selling, and speculation, which produce instability, are not part of the Islamic banking.

Islamic banking system leads to more prudent lending by encouraging financiers to invest directly in an entrepreneur's ventures. Also, by avoiding the need for enticing interest-based loans, people are encouraged to keep spending within their limits in contrast to the consumerist society that depends heavily on a financial system that continually encourages a ‘buy today, pay tomorrow’ philosophy. Islamic banks do not encourage overdraft facilities.

The 2008 financial crisis of the capitalist system, which is based on usury and securities rather than commodities in markets, shows that it is undergoing a crisis and that the integrated Islamic finance, if properly applied, can replace capitalism, says Shaikh Yusuf al Qaradawi, a leading scholar.

Islam provides the only true path to an economically just society because it exalts a social contract over wealth generation for a few, places strict limits on risk-taking and does not deal in debt trading. Also, silent partners receive no more profit than is proportionate to their investment, while the working partners get more profit, reflecting an emphasis for reward on work than merely possessing capital.

To sum up, Islamic banks offer higher rate of return; lower risk exposure and better risk management compared to conventional banking.

(Oman Daily Observer / 15 April 2013)

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