This article is authored by Anvita Bhardwaj, from Symbiosis Law School, Noida. This article discusses the principles of Islamic Banking System and the economic relevance of the same. 

Introduction

Islamic banking, better known as “Sharia Compliant Banking” can be simply defined as an interest-free banking system. This religious banking system works on two main principles of Islamic economics:

1. Profit-sharing.
2. Non-indulgence in payment or collection of interest. (Riba)

Islamic banking can be defined as a banking activity that applies the principles of Sharia Law practically. In this system, the creditor cannot charge a specific rate of interest from the debtor. He is prohibited from doing so as Sharia considers the act of acceptance of specific interest (usury) as “Haram” (unholy and forbidden). The principle remains the same despite it being a floating or fixed investment. 

The rulings and jurisprudence (fatwa) provided by other Muslim scholars also form the principles of Islamic banking. Interpretation of these laws and ruling is proven difficult for ordinary people who do not have religious knowledge. This has led to Islamic banks appointing a board comprising “Sharia Scholars”.    

These principles are majorly used in Muslim majority companies; however, owing to the economic advantages posed by Islamic Banking, countries like Japan and the UK have also adopted it. I believe that Islamic Banking is ethical banking and is advantageous to people irrespective of their religion. An old survey report released by the International Monetary Fund (IMF) shows that 10-15% per year growth is shown by the Islamic Banking Industry. An industry which is currently spread over 51 nations and 300 financial institutions.

Seeing this rapid growth of interest it can be safely assumed that the trend of Islamic Banking may prosper in the years to come and replace conventional banking systems.

Legal validity of Islamic Banking in India

Under Article 14 and Article 15 of the Indian Constitution, the right to equality is guaranteed to every person in India prohibiting discrimination on the basis religion amongst four other grounds. However, Islamic banking does not violate the principles embedded in the Constitution of India. It is an ethical banking system which benefits Muslims and people belonging to other religions equally. When considering the application of Islamic Banking in India, the question of fundamental rights violation does not come up.

Further, Article 14 empowers the State to make positive discrimination. This can be done if two objectives are fulfilled:

• Classification is made on reasonable grounds following the principle of Intelligible Differentia. In India, the Muslim class is the largest minority. 
• The classification should be rational and fulfil an aim. With the introduction of Islamic Banking financial disparity will be reduced. This enables the State to form separate legislation on the grounds of Sharia.

Under Section 17(1) of the Reserve Bank of India (RBI) Act, empowers RBI to accept monetary transactions without any interest from the government (Central or State), banks, local authorities or other persons. Therefore, if we apply the principles, we can see that only RBI is legally authorized to undertake Islamic Banking. 

Under Section 5(b) of the Banking Regulation Act, banking is defined as accepting, investing, and lending money which is repayable on demand and can be withdrawn via cheques or drafts or other instruments. Section 5(c) defines “banking policy”. Nowhere in this Section “interest” is mentioned as a prerequisite for banking. This opens up the possibility of Islamic Banking in India.

Therefore, Islamic banking can be constitutionally upheld, it is not communal, and the benefits of it can be reaped by the whole community.

Key principles of Islamic finance

Muslims usually avoid institutions such as banks. Their Islamic religion prevents them from using banks as Islamic beliefs prevent people from indulging in dealings where the sin of usury is committed. Yet the community has found ways to carry on financial activities relying solely on the principles of Islam.    

Interest-free banking and Profit Sharing

The first and foremost principle is the prohibition from collecting interest on high rates. The Holy Qur’an forbids charging Riba (i.e. charged interest or usury). This is the fundamental of Islamic Banking. Sharia disallows Riba. Muslim economists have widened the scope of this term as they believe Riba is not restricted to usury but also to charging interest on a fixed rate. 

Qard-al-Hassan (translation: good loan) is the only kind of loan one is allowed to undertake in accordance with Sharia. Any predetermined amount above the principal is strictly prohibited. The practice of making money from money is shunned. The only acceptable use of money is the representation of purchasing power. Purchasing power should not increment purchasing power(money) without going through an intermediate step.

The enterprise for which the money is lent should share the profit as well as the losses. Investment and partnership are encouraged by Islam as this leads to sharing of profits. The loan with agreed interest has to be paid back despite losses. Profit-sharing is encouraged so that the community benefits as a whole.

What is Ijarah

The concept of leasing under Islamic financing is known as Ijarah. An asset is advanced to a person in exchange for money. Temporary possession is transferred to the lessee and ownership is retained by the owner. The scope of Ijarah includes lease, rent as well as wage. Under Ijarah, a consumer can enjoy the use of specific assets (heavy machinery, vehicles, etc.)  for a fixed amount of money and a fixed period of time. The main advantage of Ijarah is that collateral is not required. The procedure of repossession is much simpler as the ownership is retained. 

Conditions of Ijarah

1. The lessee should get access to the items upon completion of the lease agreement. 
2. The items should not be defective and useful for task performance.
3. The tenure and amount should be fixed prior. 
4. The lease payment must be activated upon acquiring the item despite it being in use or not.
5. Conditions of usage must be mentioned.
6.  Prior to leasing, the lessor must have all legal and ownership rights of the item.
7. Existence of items must continue throughout the agreement, for example, “ammunition or firecrackers” cannot be leased as they get consumed and cease to exist. 
8. Maintenance duty lies on the lessor throughout the agreement.
9. Termination on grounds of non-repayment or late dues may occur.
10. Damage caused due to negligence can be collected from the lessee. 

Prohibition of Riba (Interest)

As mentioned in the Holy Qur’an (Al Baqarah 2:278-9), it is asked of the believers of Allah to not accept Riba and fear his wrath if they fail to adhere to it. They can repent by returning the Riba collected. Sharia scholars and Muslim economists share the same interpretation and consider Riba to be “Haram”.

Till date, Riba has been classified into two categories:

• Riba An Nasiyah: This form of Riba is the primary form; it is the excess over the principal amount. It has been mentioned directly in the verses of the Qur’an. 
• Riba Al Fadl: This form of Riba is used to denote “excess compensation without consideration” which stems from sales of goods. The source of this is a famous hadith.

Sanctity of contract

Four basic rules should be followed to maintain the sanctity of an Islamic Contract:

1. The contract should have a valid condition. 
2. Unless and until it is proven by the Qur’an and the Islamic law, a condition which seems immoral but exists in the market economy cannot be invalidated. The contract will be valid. 
3. A condition that is contrary to Islamic law but acceptable in the market economy would still render the contract void.
4. A condition which favours none (the law, the market economy or the contractor) is a void condition.

Risk mitigation in Islamic banking

Financial contracts based on interests differentiate entitlement to return from the responsibility of the loss. This is done by protecting both the principal amount and the rate of interest levied on it. In this process, the risk associated with loans is transferred to the debtor while the creditor retains the ownership of funds.

In contrast, Islamic banking does not make this differentiation. This results in the mitigation of risk transferring and encouragement of risk-sharing.   

To what extent is RBI supporting the concept of Islamic banking in India

Currently, RBI does not support Islamic banking in India because Islamic banking is totally different from regular banking. However, there is a scope for Islamic banking in India which will not only benefit the Muslims but people from other religious backgrounds as well. Given the proper support from the public, Islamic banking can be easily sustained in India. It can function as an NBFC (Non-Banking Financial Corporation), and the official language for the operation can be changed to English in Non-Islamic Nations such as ours. 

Current situation in India 

Kerala has become the first state in the country to establish its very own Sharia Compliant Bank. This happened with the support of the Communist Party of India (Marxist). The bank is in Kannur district and has helped in bringing forward investments by Muslims who shunned the conventional banking system. The Halal Faiydah will not charge any interest and only invest in activities considered “Halal” or legitimate under Islamic Law. The investment of money is therefore prohibited in pork, alcohol or gambling.   

Indian banks must exploit the untapped benefits of Islamic banking 

• A large number of Muslims in India need Islamic Banking. Introduction of the same by the government and the RBI will make banking more inclusive in India. Indian Muslims will invest in Islamic banking and they amount to 14.9% of the population of India making them the largest minority in India. 
• Islamic Banking will solve the problem of inflation and liquidity to an extent. It will boost India’s economy.
• Through its financial services, Entrepreneurial Development can be boosted in India.
• The Islamic banking system has a lot of advantages in contrast to traditional banking which demands high rates of interests, and foreclosures due to payment default. It is ethical and works on the principle of equity.  
• The flow of funds from the Gulf Council will be an added advantage.
• Creation of job opportunities and new fields of study.

Conclusion

In my perspective, Islamic banking is the way to move forward! It will uplift the financial activities of Muslims in India without harming any other religious faction. The benefits of Islamic banking are far too good to be ignored. Interest-free and equity-based principles make it all the way more attractive. They have greater resilience to crisis and shocks. It will not only be more inclusive but all will support small and medium-sized enterprises.  

Also, with the advent of Islamic banking, the labour-capital ratio will improve. This will boost Indian agriculture and the informal sector. Another problem with conventional banking is that it increases disparities between classes, the rich become richer and poor become poorer but with the help of Islamic banking, the profits will percolate to lower levels of society and reduce the disparity due to class aspect.    

The conventional banking system is exploitive. However, one cannot ignore the few risks associated with Islamic banking. As per IMF, the risks involved with Islamic banking is terrorism financing and non-compliance with FATF (Financial Action Task Force) on money laundering. Destruction of money transfer transaction records is very common with Islamic Banks and might lead to a lack of audit trail. This will make our economy a “grey and black economy”. 

Is undertaking these risks worth all the untapped advantages? Only time can tell. Islamic banking has already made its way in the Western countries and has proven to be successful as of yet. In fact, some studies have shown that more non-Islamic population is investing in these banks as compared to Muslims.

Should India allow the practice of Islamic banking? Let us know your opinion in the comment section! 

References

• https://www.imf.org/external/pubs/ft/wp/wp9830.pdf

• https://islamicmarkets.com/publications/need-for-islamic-finance

• https://www.bartleby.com/essay/Principles-of-Islamic-Banking-F36ATNZTJ

• https://www.isfin.net/sites/isfin.com/files/risk_management_in_islamic_banking.pdf 

• https://www.imf.org/en/News/Articles/2015/09/28/04/53/sores0919a 

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