Islamic Banking
Islamic Banking

An introduction to Islamic Banking

Some of the most famous investment banks in the world, such as Goldman Sachs, Lehmann Brothers and Rothschilds are Jewish origin. Shylock, in the Merchant of Venice, was a Jew. This is for a specific reason – for a long time, Christianity prohibited the charging of interest, and hence, Jewish establishments which offered banking and financial activities flourished.

The story of Islamic finance is similar. Shariah law prohibits the charging of interest (interest is called riba as per Shariah). This does not mean that banks cannot run operations profitably. It simply means that banks run their operations differently – they work as partners in a client’s business, instead of charging ‘money for money’. In a transaction compliant with Islamic law, the bank undertakes the risks associated with ownership of assets. The business is a kind of joint venture.

Islamic law also prohibits transactions which are speculative (such as gambling) or have a significant amount of risk or uncertainty (gharar). Derivatives and contingent contracts are usually invalid, and commercial transactions involving elements of uncertainty need to be carefully structured so that they do not fall foul of this prohibition.

Islamic finance in the global economy

Political regimes in global financial centres had sensed the growth opportunities from Islamic finance early on and accordingly tailored banking laws to permit Islamic products. As a result, Islamic finance has flourished in London, Paris, and Tokyo.  During the financial crisis, Islamic finance also served as a cushion to mitigate the impact of the liquidity crunch.

The Indian connection

India can benefit for Islamic finance for three compelling reasons:

1. India has the second largest Muslim population in the world. This segment of the population needs access to personal finance. Conventional banking products are not in accordance with their personal law and are not fully accepted by the market segment.

2. A high level committee report (known as the Sachar Committee report) in India had pointed out that certain sections of Muslims are very backward in India, and do not use the banking sector. The policy goal of financial inclusion can be met if financial products offered to Muslims are not repugnant to their personal law.

3. India has substantial need for inward investment for its infrastructure development goals, and post the financial crisis, sourcing investment from the Middle Eastern nations is a huge opportunity for India. Mr. H.Abdur Raqeeb, convenor of the National Committee for Islamic Banking and general secretary of Indian Center for Islamic Finance, has pointed out that India needs approximately US $ 500 billion in investment in various sectors in the next 10 years.

However, investors from Islamic nations such as the Middle Eastern countries prefer Islamic law compliant vehicles before they invest in India. The most recent available government data (as of March 2011, from the Department of Industrial Policy and Promotion, Government of India) suggests that UAE has a meagre 1% share of the total foreign direct investment in India. Permitting Islamic finance can fulfil a sizeable portion of India’s investment needs.

The next post shall throw light on the early movers and their plans for Islamic finance.


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