a pen on a why should banks in
India follow the Islamic Banking Law
Banking has been an integral component of every economy. In India too, it has evolved through a long journey and has attained pinnacles over the period. Today, it stands tall with a strong pillar base comprising of the nationalised banks, private banks and foreign banks. There has been a tremendous change in the way banks operate in terms of use of technology, managing customer relations, development of new products, etc. The only thing, which has remained static, is the fundamentals of banking.
However, with the force of change across all industries, banking seems to be the most affected one. Globalisation has made it impossible for the country to stay shielded from the global crisis. To our destiny, India’s banking industry is among the very few in the world which has been able to survive the storm and maintain resilience.
The financial crisis of 2008 became glaringly evident with the failure and collapse of several large banking houses in the United States. The banks in India could not escape without being hit by the storm and in no time started suffering from cash crunch, the causes, as we all know global recession and the monetary policy decisions to control inflation. However, in these conditions too, they were able to sail through, due to limited exposure to bad assets, thanks to the Indian Banking system, which is well-regulated and financially sound.
The world is not just witnessing a drastic change in its climate, but also in its economic conditions. The storm called recession hovers across the globe with fears of onset every 5 years. The horizon at which this storm occurs has reduced over the years and the world now faces a risk of falling into another recession. Though the world economy is showing progress in terms of reduced unemployment, bullish stock markets, increased industrial outputs, etc., analysts and experts consider this situation to be temporary and expect the economy to pass through another round of recession soon.
Taking these conditions into circumstance is there a vessel, which enables everyone to survive and wade through this rough sea with minimal destruction?
Can there be a system, which has strict compliances and practises to ensure that interest of its stakeholders, is never put at stake?
For an economy to grow steadily, it requires a sturdy base of savings backed by ample institutional arrangements for deployment of these sums such that it meets the requirements at all times. A well-developed capital market becomes an indispensible prerequisite for allocation of savings in the economy. This system must also be flexible enough to adapt to the ever-changing economic conditions.
To mitigate all the fears we hold, a system of banking instilled with the principles of equity and justice, which is widespread and successfully implemented around in many parts of the world, under the banner ‘Islamic Banking’ needs to be adopted. This system has its roots back to the early sixties, where the need to differentiate lawful activities from prohibited activities was identified. The seed of this form of banking has been sowed so well that it has never looked back since then and has continued a strong spree of growth despite the crisis that has burnt the pockets of the conventional banks globally.
Islamic banking is a system in consistent with a law, which is against collection or payment of taxes. It also believes that inflation sources itself from interest and accumulation of the amount leads to increase in divide among the rich and the poor. Mortgage system is followed instead of loaning an amount to the buyer to purchase the product, a bank might itself buy a product and re-sell it to the individual seeking a loan at a profit, while allowing him to pay the bank in instalments.
There are some basic laws that which are supposed to be followed as per the Islamic banking norms, for example prohibition on collection and payment of any kind of interest, prohibition in investing in business that are considered unlawful, etc.
In the book, the ‘Future of Money’ by Bernard Lietar, he has very well highlighted the dangers of interest and then mentioned how this system has represented the last bastion of resistance. He has also gone further and explained interest, as a direct cause of inflation and thereon the concept the rich getting richer and poor getting poorer.
Following are some of the financing options made available as per Islamic Banking Law:
a. Murabaha – Cost Plus Financing
b. Ijara – Leasing
c. Mudaraba – Profit sharing
d. Musharaka – Joint Venture
e. Al Rahn – Short term Financing
f. Salam – Forward Purchasing
g. Qarhd – Non Profit Loans
Islamic banking has a huge market potential in India. India is 3rd largest Muslim populated country. Not that the banking system has anything to do with the community as such but the financial inclusion will lead to a feel good factor amongst the community. If we think of it further, it leads to a diplomatic advantage to the government to make dealings with Muslim dominated nations and thereon attract financing for infrastructure and other development and reducing the fiscal deficit of the country.
The Sachar Committee report has highlighted that approximately half of the Muslim population are financially excluded. It also points out that introduction of the Islamic banking system would lead to an inclusion of majority of this population and thereon an increase in the size of banking industry manifold.
Way back in time, a one on one interview with executives of personal banking division of various banks revealed that significant Muslim population is:
a. Against investing in funds which include a debt component
b. Donating the interest competent received on their saving account
c. Using zero interest account
This can take us to only one conclusion, as to that there are individuals, who in their own way follow the Islamic law.
Experts have termed the Islamic Banking System as a one of the best recessionary proof system of banking in the World.
The Troubles:
Indian banking law does not explicitly prohibit the introduction but certain provisions in the current system makes it almost unviable for introduction. Following are some of them:
a. Various laws regulate banks and one of the features of these acts is that the banks can accept deposits from public only for further lending. They also prohibit banks from investing on profit and loss sharing basis in other companies. Furthermore, it restricts banks to directly or indirectly indulge in buying or selling or bartering of goods.
b. The government interferes in the balance sheet by directing banks to provide concessional credit to priority sector.
c. The CRR and the SLR requirements.
The Solvent:
Besides banking to which there are various law that apply, there are non-banking financial institutes, which can think of following the Islamic principles of finance without much of a change to do.
On its part, government too can introduce some schemes for banks willing to follow these principles under which, instead of payment of interest, it can agree to share profits earned on investments. A research paper shows that nearly 50% of the companies on BSE500 happen to follow Islamic finance parameters and therefore banks can invest and earn handsome profits.
Special Thanks to Varun Misar, for co-authoring this article with us.
This article was first published in Niveshak, Finance Magazine, Indian Institute of Management
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