Islamic Banking : All You Need To Know

The purpose of this article is to highlight what is Islamic Banking,its need and accompanying challenges. Islamic Banking is a subset of a broader concept of Islamic Finance which include Islamic insurance (aka Takaful) apart from Islamic banking. Islamic Finance is Sharia law based system of finance, which in turn finds its source of standards and law in Holy Koran and Hadeeth(sayings of Prophet Mohammad).

Islamic Banking operates on basic principles like

• It prohibits any receipt or payment of Interest (Riba)and considers it as 'haraam', however it promotes profit (loss) sharing.
• It prohibits application of money for alcohol,tobacco,pork processing,speculation,betting,etc.
• It prohibits trading in Debt, hence Islamic banking compliant banks issue Sukak or Islamic Bonds which are in spirit to the Sharia law.

Ways in which Islamic Banking is done are:

• Mudarabah, a profit-sharing agreement.
• Wadiah, a safe keeping arrangement.
• Musharakah, or a joint venture for a specific business. 
• Murabahah, cost plus arrangement where goods are sold with a pre-determined margin of profit
• Ijirah, a leasing arrangement.

The reason for disallowing interest earning is based on the principle of 'No Money without Risk taking' if done so it is considered to be exploitative.Furthermore the law promotes entrepreneurship.

Very natural question is why we need it? The answer lies in its potential for acting as an alternate to conventional banking system and by acting as an agent of financial inclusion and overall growth of the banking industry.Post global financial crisis the importance of Islamic banking has been realized, for the reason it is devoid of interest factor which is the central point of present system hence insulating itself from risks associated.West Asia, Malaysia, Indonesia,etc. are the countries where the system of Islamic banking is gaining currency.Notably, the assets of Islamic Banks have risen at an average rate of 15% over the last decade.It may act as an all acceptable measure of innovative and inclusive growth. Islamic Banking is not for muslims alone,in countries like U.K., Malaysia more than 40% of the customers of these banks are non-muslims.

For India, Islamic Banking holds vast array of promises, firstly it will increase investment by muslims in particular, finding the system in sync with their religious belief and by others in general.Further flow of money from Indian diaspora settled outside especially West Asia will increase,Sukuk may be used for infrastructure financing.Above all it will augment the entrepreneurial spirit in the country.

However several challenges need to be given heed to. There is serious conflict in banking laws in force in our country and Islamic banking principles.Present law mandates compulsory payment of interest on deposits and prohibits any sort of trading unrelated to the business of banking which are pillars of Islamic Banking. Ex- RBI Governor also stated incongruity in present laws to accommodate sharia based banking. Procurement of Funds for operations require mass awareness and participation. Utilization of funds for specified purposes entails closer supervision along with commensurate infrastructure and competent personnel. We need to move to Islamic Banks from just allowing NBFCs to operate that way.It will certainly help attaining national objective of financial inclusion.