What Is Islamic Banking

ISALAMIC BANKING

As far as I could understand, I could grasp the following principles in "Islamic Banking".
http://importantbankingnews.blogspot.in/2013/08/kerala-government-get-permission-from.html

1. It is claimed that "Contrary to popular belief, Islamic finance or banking is not just for Muslims. It aims to lay the foundations of an ethical and fair financial system, which consequently affects the socio-economic conditions of the market it is implemented in. Islamic financing, hence, can aptly service everyone irrespective of religious beliefs, wealth, ethnicity, caste or creed".
2. Islamic banking must stay within the limits of Islamic law and Shariah in all actions and transactions. Islamic banking is done by laws and regulations which are defined in the Quran and Sunnah in which the product or services are not introduced by the Islamic banks which contradicts the Islamic values.
3. Interest is prohibited for both acceptance of deposits and lending. ‘Riba’ (interest) is a very important term in the Islamic terminology showing disapproval and it refers to the instrument by which a loaner charges some amount lump sum or in installments over and above his principal amount from the loanee and thus increases his wealth manifold without participating in the business process of profit and loss.
4. But, unlike in conventional banking, the creditor-debtor or debtor-creditor relationship does not exist in Islamic Banking. On the contrary, investors, partners, buyers and sellers exist in Islamic Banking.
5. Islamic financing is asset-backed and believes that only assets with an intrinsic value may be sold for a profit, instead of exchanging money – which is considered to have no intrinsic value – for interest. Each unit of money has the same value as the other of the same denomination, which is simply why there cannot be a profit on its exchange. Hence, Islamic finance lays its foundation on real, non-liquid assets; the exchange and sales of which result in ‘fair’ profits.
6. Though giving and taking of interest is prohibited, some transaction fee may be collected as per the tenets of Shariah law.
7. In Islamic banking, in case of defaults, the extra amount (not penal interest) charged to customer will go for charity not in the bank’s income.
8. The accounting and auditing of both conventional banking and Islamic Banking systems are to some extent similar, but the documentation in Islamic banking is different as compared to conventional banking.
9. If a person wants to start his business he will take a loan from a conventional bank and pay the principal amount plus interest on that. On the other hand, if the same person goes to an Islamic bank, the Islamic bank asks him about the type of business he wants to start and provides all resources or material to him to start his business instead of giving him only cash and charge some fees on that.
10. In conventional banking, the bank shares its profit with the investors. But in Islamic Banking, both profits and losses are shared with the investors.
11. In fact, since deposits in Islamic banks are treated as shares and accordingly their nominal values are not guaranteed, holding reserves hurt Islamic banks in two ways. One, reserves do not yield any return to the banks and two, holding reserves requirement reduces the amount of funds available for investment. From a policy perspective, one can argue from the results that Islamic banks should be exempted from the reserve requirement, in particular, because they are not entitled to discount loans or last resort borrowing from their central banks.
12. By the end of December 2008, in more than 50 countries approximately 300 institutions are operating and they manage funds of US$ 951 billion. Persian Gulf Area is the centre of Islamic finance with a share of 82% followed by South Asia and Far East region 13% and balance from all over the world including Europe, North America and Africa (IFSL 2010). So for (June 10) six full-fledged Islamic banks and 13-conventional banks with Independent Islamic Branches are operating in Pakistan.

Positive points of Islamic Banking

1. Interest is not the motivating force for monetary transactions, because money is not a commodity to lend or borrow.
2. Usurious interest is not charged.
3. Penal interest is not charged for late payment.
4. In Islamic banking, in case of defaults, the extra amount (not penal interest) charged to the customer will go for charity and not to the bank’s income. 
5. Major thrust is given to social banking as against commercial banking. Because of this, instead of seeing the creditworthiness of the borrower alone, viability of the project is reckoned.

Shortcomings of Islamic Banking

1. In case of loans, instead of money, commodities and materials are supplied. This takes away the choices available to the borrower.
2. There is no guarantee for the deposits (investments/shares) kept with Islamic Banks.
3. The investors must also be prepared to share the risks and losses of Islamic Banks.
4. Since there is no penal interest, repayment discipline is neither ensured nor encouraged.
5. There is no uniform, objective, structured and scientific tool for the fees for different types of transactions.
6. Islamic Banking includes buying and selling of assets with intrinsic value (physical assets as against monetary assets). This is very much against the concept of 'money' based banking.
7. Keynes says "Interest lulls our disquietude". Therefore, most of the investors expect interest on their investments rather than anything else. 
8. Similarly, in case of commodities and materials supplied, there may be disputes with regard to their quantity, quality and valuation.
9. Unnecessarily, religious concepts are introduced in the form of Shariah, in banking industry.

Date: 19-08-2013                                                                                              V Subramanian

ISLAMIC BANKING – 

Shattering the concept of 

Commercial Banking

by

Rajesh Goyal  

I have been hearing about Islamic Banking for last over a decade but have been able to gather only some basic information.  Now  in August 2013, after the proposal for appointment of Raghuram Rajan has been cleared, it has come in fresh discussions as the new RBI Governor is considered to be a strong advocate of this concept.  The financial reforms commission headed by Rajan had even advocated Islamic banking.

Following the above, now it has been reported that Kerala Government has got a go ahead from Reserve Bank of India to launch a financial institution following the principles ofIslamic finance.   The reports indicate that Cheraman Financial Services Limited (CFSL)  will be floated by Kerala State Industrial Development Corporation to function as a non banking finance company (NBFC).  The entity is likely to function as NBFC with an authorized capital of Rs 1000 crores, and has received clearances from RBI, SEBI and Wakf Board.  KSIDC will be the single largest shareholder in the company holding 11% shares whereas other individual shareholders can hold a maximum of 9% shares.

Before I share with our readers what I do not understand about this banking and the questions which needs some answers from our Muslim readers and / or people who have worked in Islamic countries , I will try to explain here what is Islamic Banking as understood by me. 

 What is Islamic Banking ?

Islamic Banking in brief can be described as a banking activity that is consistent with the principles of sharia and its practical application through the development of Islamic economics.  The foundation of Islamic bank is based on the Islamic faith and must stay within the limits of Islamic Law or the Shariah in all of its actions and deeds.

The literature available at present indicates that the major governing principles of an Islamic bank are:-

* No interest-based (In Islam is is called Riba) transactions i.e. neither the interest is paid to depositor nor it is charged from the borrower;

* No support to economic activities involving oppression (zulm)

* No financing to economic activities involving speculation (gharar);

* The introduction of an Islamic tax, zakat;

*No financing for the production of goods and services which contradict the Islamic value (haram)

The word "Riba" means interest, usury, excess, increase or addition, which according to Shariah terminology, implies any excess compensation without due consideration (consideration does not include time value of money).    Riba is indeed deemed haram in Islam, for the reason that it is ‘unfairly’ exploitive in nature. It is ‘unfair’ because Riba requires the lender to return the borrowed money, plus an extra amount. This requires the borrower to work harder to return not just the principal, but also the interest or mark-up levied on the amount.

A reading of the above details has left me unanswered for some of the questions, which I am giving below and invite our readers to give their views or additional information in comments so that we can create a good document on this new concept :-

(a)             How Isalamic Bank will generate revenue in the absence of interest received?  Who will pay for the salaries of the staff in the Islamic Banking when there will not be revenue.  The majority income of banks is always from interest.   Thus, in this era of high salaries and high rent for bank buildings, how Islamic Banks will pay for their staff and establishment expenses?   Do they will involve something like Kar Seva as is done by Sikhs at their religious places?  Will there be permanent employees;

(b)            Will rules and regulations as applicable for commercial banks like CRR, SLR, Basel III norms applicable to such banks?

(c)             Will there be any guarantee for depositors?  Will there be restrictions on withdrawal of funds by depositor on demand?

(d)  Will government all religions to open separate Banking systems with different set of regulations?  For example, Sikhs are great businessmen and have huge earnings abroad and are always ready to contribute for religious chartiable organisations.  Will they too be allowed to start Sikh Banking?  On similar lines, will Christians and Hindus (may be VHP or RSS) also allowed to start parallel banking? 

In a democracy like India, can two / three / four  parallel  banking system work, specially in free competition world.   The cost of production for corporate who will take loans from commercial banks (mostly non-Muslims) will be more than the cost of production of corporate who will be able to avail loan fromIslamic Bank at free of interest.   How will they compete with each other in the free market.

In case this methodology or banking system is adopted across India, how will senior citizens, who are mainly dependent on interest income will survive?  Will government provide social security for them?   In case, this system is partially adopted, it can reduce interest rates drastically for depositors and thus old will be at the mercy of the existing bank balance which will not earn any interest.

With above ideas, I through this discussion open for our bankers to ponder on these issues and give their views and how does two parallel system will be compatible since we will soon see first institution based on Islamic Banking.